Overview: Externalities and Property Rights

StartTable of ContentsIndex

Reading Selections:

On The Internet:

Who's Who

Economists have argued since Adam Smith that markets tend to be efficient, that the "invisible hand" works. However, they have discovered that the conditions needed for a whole economy to be economically efficient are so restrictive that they will not in practice happen. All buyers and sellers must be price takers. Information must be good and equally available to buyers and sellers. Private-property rights must exist and be complete. When these assumptions are not satisfied, the market can fail to allocate efficiently.

This group of readings considers the problems an exchange economy has when an activity helps or harms others who take no part in the activity, which happens in the cases of public goods, positive and negative externalities, and the problem of the commons. Economists are interested in this topic because it challenges the presumption that competitive markets will be economically efficient. In other words, they see externalities, public goods, and common property situations as sources of market failure.

After you complete this unit, you should be able to:

  • Distinguish between positive and negative externalities and give an example of each.
  • Explain the logic behind the problem of the commons.
  • Explain why the problem of the commons encouraged the development of private property rights.
  • Explain why the market will not normally provide a public good.
  • Explain why economists prefer pollution taxes to direct regulation, but businesses do not.
  • Define and give examples of free riders and network externality.
  • Explain how the free-rider problem reflects the prisoners' dilemma.
Copyright Robert Schenk