15. Externalities and Transaction Costs. Экстерналии и транзакционные затраты.

When individuals impose costs on or provide benefits for others, but don’t have an economic incentive to take those costs or benefits into account, economists say that externalities are generated; that can lead to market failure if not properly taken into account.

Both external costs (uncompensated cost imposed on others) and benefits (conferred on others without receiving compensation) are externalities. Pollution is an example of an external cost, or negative externality; in contrast, some activities can give rise to external benefits, or positive externalities.

Pollution example.

There are costs as well as benefits to reducing pollution, so the optimal quantity of pollution isn’t 0. Instead, the socially optimal quantity of pollution is the quantity at which the marginal social cost of pollution (marginal cost of production + marginal external costs) is equal to the marginal social benefit of pollution (marginal individual benefit + marginal external benefit). Left to itself, a market economy will typically generate too much pollution (> than socially optimal quantity) because polluters have no incentive to take into account the costs they impose on others. That is why the government regulation is needed.

Governments often limit pollution with environmental standards. Generally, such standards are an inefficient way to reduce pollution because they are inflexible. When the quantity of pollution emitted can be directly observed and controlled, environmental goals can be achieved efficiently in two ways: emissions taxes and tradable emissions permits. These methods are efficient because they are flexible, allocating more pollution reduction to those who can do it more cheaply. They also motivate polluters to adopt new pollutionreducing technology.

An emissions tax is a form of Pigouvian tax (that designed to reduce external costs). The optimal Pigouvian tax is equal to the marginal social cost of pollution at the socially optimal quantity of pollution. It yields lower output and a higher price to consumers, which means decreased MSC.

(In case of positive externalities government may introduce Pigouvian subsidy, a payment designed to encourage activities that yield external benefits, that, if optimal, would be equal to marginal social benefit. It would lead to higher ouput and lower price, which means increased MSB)

And yet, according to the Coase theorem, the private sector can sometimes resolve externalities on its own: if transaction costs (communication, legal, bargaining) aren’t too high, individuals can reach a deal to internalize the externality (take external costs and benefits into account while making a decision). In all other cases, when transaction costs are too high like in pollution example, government intervention is needed.

Network externalities arise when the value of a good increases when a large number of other people also use the good (e.g. communications, transportation, high tech). Goods with network externalities exhibit positive feedback: success breeds further success, and failure breeds failure. Markets with network externalities tend to be monopolies, posing special problems for antitrust regulators. It can be difficult to distinguish what is a natural growth of the network and what are illegal monopolization efforts by the producer.