ABSTRACT
This chapter explores how actions by individuals and firms can impose costs or confer benefits on others—externalities—and how these affect market efficiency. We distinguish between negative externalities (e.g., pollution, congestion) and positive externalities (e.g., education, vaccination), analyzing how unpriced side effects lead to overor underproduction. Policy tools such as Pigouvian taxes, emissions quotas, and tradable permits are examined for their roles in internalizing externalities. We introduce the Coase theorem, emphasizing how well-defined property rights and low transaction costs can lead to efficient outcomes through bargaining. The chapter then classifies goods by rivalry and excludability, explaining private goods, public goods, common resources, and club goods. We study underprovision of public goods due to free-riding and overuse of common resources due to lack of exclusion. Examples include climate change, congestion, fisheries, innovation, national defense, and radio broadcasting. Mechanisms such as taxation, regulation, social norms, and local governance are discussed as solutions.
