An externality is a cost or benefit of an economic activity that falls on a third party who did not choose to bear it, rather than being fully reflected in the price paid by the buyer and seller who made the transaction. A factory that pollutes a river imposes a negative externality on downstream users, while a beekeeper's hives can create a positive externality for a neighboring orchard's pollination. Because externalities are not priced into private decisions, economists since Arthur Cecil Pigou have argued that markets left alone will produce too much of an activity with negative externalities and too little of one with positive externalities, a central justification for taxes, subsidies, and regulation aimed at correcting the difference between private and social cost.
Facts
Proposed ByPigou developed a concept his teacher Alfred Marshall had already sketched. SignificanceExternalities matter because a cost or benefit landing on an uninvolved third party is not reflected in market prices, so left alone a market produces too much of an activity with a negative externality and too little of one with a positive externality, which is the standard economic case for taxes, subsidies or regulation. 3 Classification
Concept Form Connections
Associated With
Overuse of a shared resource, the scenario Garrett Hardin described as the tragedy of the commons, is a classic negative externality: each user's consumption imposes uncompensated costs on every other user of the same resource.
Source The New Palgrave Dictionary of Economics
Associated With School
The Pigouvian tradition treats externalities as a market failure to be corrected by a tax or subsidy.
Source Principles of EconomicsAlfred Marshall
Critiqued Here
Why this is disputed. Coase argued that with clearly defined property rights and low bargaining costs, private parties can resolve externalities by negotiation without government correction, a direct challenge to the Pigouvian tax prescription.
Source The Problem of Social CostRonald H. Coase
Attributed To
Source The Problem of Social CostRonald H. Coase
Sources
1. Externality (Wikipedia)
lead paragraph, sentence beginning: In economics, an externality is a cost or benefit to an unin
In economics, an externality is a cost or benefit to an uninvolved third party that arises as an effect of another party's (or parties') activity.
- Externality
Wikipedia, Externality, lead section
In economics, an externality is a cost or benefit to an uninvolved third party that arises as an effect of another party's (or parties') activity.
View the Source2. The New Palgrave Dictionary of Economics
Palgrave MacmillanExternalities
3. Wikipedia
Wikimedia FoundationContributions to economicsQuote, Contributions to economics
In The Economics of Welfare (initially called Wealth and Welfare), Pigou developed Marshall's concept of externality, which is a cost imposed or benefit conferred on others that is not accounted for by the person who creates these costs or benefits.
Principles of Economics
Alfred Marshall, Macmillan, 1890Associated With School: Neoclassical Economics
The Problem of Social Cost
Ronald H. Coase, Journal of Law and Economics, 1960- Associated With School: New Institutional Economics
Attributed To: Ronald Coase, Section I
The Problem of Social Cost reframed externalities as a reciprocal problem of conflicting resource uses rather than a one-directional harm requiring a Pigouvian tax.
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