Public Policies, Markets, and Externalities

Abstract

The absence of externalities is one of the conditions required for competitive markets to achieve efficient resource allocations. Externalities occur in situations where the activities of one economic agent affect or spill over into the technology, consumption set, or preferences of another agent. Externalities, which may be positive (in that case, they have beneficial external effects) or negative (in that case, they have adverse external effects), are one example of market failures. They mainly arise from the fact that environmental goods and services often have no market. The environment is considered as a free resource, which is zero priced and therefore overused. When interaction between private agents does not result in an efficient resource allocation, government intervention is required in order to internalize external effects. Nevertheless, even in the absence of market failure, government intervention may also be justified mainly for equity or national industry protection reasons. This chapter addresses only the problem of externalities and environmental policy strategies, emphasizing those relevant for agriculture activities and resources.