Bill Scott's blog

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Externalities and Arthur Pigou

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Uncosted externalities are seen as a huge problem these days, and the issue must have been around for a long while, if not for ever.  The Economist had a series of articles last week in which externalities  were explored along with the work of Arthur Pigou who proposed ways of addressing them.  The synopsis is here, and begins:

MARKETS are supposed to generate a magical state, where nobody could do better without somebody else doing worse. Awkwardly, they often fail. The reason is that those directly involved in a transaction are not the only ones affected by it. A drive into the centre of town, for example, creates congestion for everyone else; a company dumping waste into a river poisons the downstream drinking water; carbon emissions warm everyone’s planet. Economists have a special name for these extra costs: they are “externalities”. Unfettered market prices do not take them into account.  ...

The main article is here.  It begins:

LOUD conversation in a train carriage that makes concentration impossible for fellow-passengers. A farmer spraying weedkiller that destroys his neighbour’s crop. Motorists whose idling cars spew fumes into the air, polluting the atmosphere for everyone. Such behaviour might be considered thoughtless, anti-social or even immoral. For economists these spillovers are a problem to be solved.

Markets are supposed to organise activity in a way that leaves everyone better off. But the interests of those directly involved, and of wider society, do not always coincide. Left to their own devices, boors may ignore travellers’ desire for peace and quiet; farmers the impact of weedkiller on the crops of others; motorists the effect of their emissions. In all of these cases, the active parties are doing well, but bystanders are not. Market prices—of rail tickets, weedkiller or petrol—do not take these wider costs, or “externalities”, into account.  ...

All very informative.  I found the part on internalities, to be particularly interesting.  Unlike externalities, which tend to affect us in a general sense, internalities are at the heart of who we are and how we live our lives.

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