ABSTRACT
An externality is the accompanying impact of one agent’s consumption or production activity on the utility or technology of another, where this impact is independent of markets or prices. A global example that jumps out at people from the Covid-19 pandemic is a person who has been infected by the SARS-CoV-2 virus but is asymptomatic. They can infect many others by riding public transport, for example, causing serious illness or death among the elderly, a negative externality. When a person gets a flu shot, they not only reduce their own chances of catching the flu, but also reduce the likelihood of transmitting the flu virus to others, a positive externality. Because externalities are external to the workings of markets, the prices at which trades occur do not reflect their additional costs or benefits. Consequently, the First Welfare Theorem typically fails, that is, in the presence of externalities, the Walras allocation is generally no longer Pareto efficient.
