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