ABSTRACT
Economic theory has assumed, at least since Pigou, that environmental externalities could and should be internalized into the price system. Pigou himself imagined that externalities would often be internalized through taxes or subsidies, a strategy that appeals to many environmental advocates as well as economists. Coase’s much-discussed alternative approach offers a different means of internalization, through negotiation; this is plausible under rare special circumstances, but it is a means toward the same end. (On the Pigou-Coase debate, see Aslanbeigui and Medema (1998).)
The optimality properties of general equilibrium are dependent on the assumption that all economic activities relevant to utility are correctly priced. In the absence of complete, correct prices, the market generates too much of activities that cause negative externalities, and too little of those that cause positive externalities. An ambitious, prescriptive form of environmental economics suggests that if externalities are priced and internalized, the market can achieve an optimum without any further intervention. On this view, which has become influential in policy circles, all that is needed is to “get the prices right” and then let market-based policy instruments work their magic (Ackerman and Gallagher 2001).
