ABSTRACT
External effects on firms - or externalities, as they are now inelegantly referred to - make their appearance in Marshall’s Principles as external economies; that is, economies external to the firm but internal to the industry. Little attention was given to this concept until Pigou’s celebrated Economics of Welfare, where, developed and extended, it appears as one of the chief causes of divergencies between ‘private net product’ and ‘social net product’. Expressed more generally, externalities today provide the standard exception to the equation of optimality with universal perfect competition. In addition to the increasingly overt recognition of this qualifying or limiting proviso, interest in the externality concept, as a phenomenon in the context of partial equilibrium analysis, has grown steadily and picked up momentum in the postwar period. Its current popularity warrants the demarcation of a new field of specialization within the broader terrain of welfare economics.
