• DOI:10.1086/466936
• Corpus ID: 154906153

The Problem of Externality

@article{Dahlman1979ThePO,
  title={The Problem of Externality},
  author={Carl J. Dahlman},
  journal={The Journal of Law and Economics},
  year={1979},
  volume={22},
  pages={141 - 162}
}

• Carl J. Dahlman
• Published 1 April 1979
• Economics
• The Journal of Law and Economics

ON the modern research agenda externalities occupy a rather prominent position. The increasing complexity of modern technology and society seems to create yet additional unwanted side effects that require classification on a lengthening list of externalities. However, externalities are of interest not only as current policy issues but also from a more theoretical point of view. Using Pigou's terminology, we say that when an externality is present there is a divergence between private and social cost. We interpret this to mean that when all voluntary contractual arrangements have been entered into by market transactors, there still remain some interactions that ought to be internalized but which the market forces left to themselves cannot cope with. This is the basis, for example, for the assertion of Buchanan and Stubblebine that "externality has been, and is, central to the neoclassical critique of market organization."' Without interference in the price mechanism, some transactions that would be beneficial are not carried out. Two conclusions follow: first, that since market forces by themselves are unable to eliminate the remaining inefficiencies, some government action is automatically necessitated; second, a conceptually feasible alternative to government action is that, through a suitable establishment of appropriate markets, economic agents can be made to take into account the side effects they generate.2 One may then inquire why market transactors are unable to make the emittor of an externality internalize the costs of his actions. The only reason why wealth-maximizing economic agents do not undertake these transactions must be that the cost of carrying out the actual transaction is greater