(8th edition) (the pearson series in economics) robert pindyck, daniel rubinfeld microecon 686

C H A P T E R

18

Externalities and Public
Goods
CHAPTER OUTLINE
18.1 Externalities
661

18.2 Ways of Correcting Market

I

n this chapter we study externalities—the effects of production and
consumption activities not directly reflected in the market—and
public goods—goods that benefit all consumers but that the market
either undersupplies or does not supply at all. Externalities and public
goods are important sources of market failure and thus raise serious
public policy questions. For example, how much waste, if any, should
firms be allowed to dump into rivers and streams? How strict should
automobile emission standards be? How much money should the
government spend on national defense? Education? Basic research?
Public television?
When externalities are present, the price of a good need not reflect
its social value. As a result, firms may produce too much or too little,
so that the market outcome is inefficient. We begin by describing externalities and showing exactly how they create market inefficiencies. We
then evaluate remedies. While some remedies involve government
regulation, others rely primarily on bargaining among individuals or
on the legal right of those adversely affected to sue those who create
an externality.

Next, we analyze public goods. The marginal cost of providing a
public good to an additional consumer is zero, and people cannot be
prevented from consuming it. We distinguish between those goods
that are difficult to provide privately and those that could have been
provided by the market. We conclude by describing the problem that
policymakers face when trying to decide how much of a public good
to provide.

18.1 Externalities
Externalities can arise between producers, between customers, or
between consumers and producers. They can be negative—when the
action of one party imposes costs on another party—or positive—when
the action of one party benefits another party.
A negative externality occurs, for example, when a steel plant dumps
its waste in a river that fishermen downstream depend on for their

18.3
18.4
18.5
18.6
18.7

Failure
667
Stock Externalities
678
Externalities and Property
Rights
684
Common Property

Resources
687
Public Goods
690
Private Preferences for
Public Goods
694

LIST OF EXAMPLES
18.1 The Costs and Benefits of
18.2
18.3
18.4
18.5
18.6
18.7
18.8

Sulfur Dioxide Emissions
665
Reducing Sulfur Dioxide
Emissions in Beijing
672
Emissions Trading
and Clean Air
673
Regulating Municipal
Solid Wastes
678
Global Warming

682
The Coase Theorem at
Work
687
Crawfish Fishing in
Louisiana
689
The Demand for Clean Air
693

661