An Integrated Approach to the Theory of Externalities: An Expository Article

Abstract:     
Traditional treatments of the theory of externalities deal separately with the output market and the “market” for effluents and have no simple geometric way to show the inter-relationships between them. This paper presents an integrated approach with a novel geometric presentation that shows these inter-relationships clearly, thereby allowing for a clearer exposition of the relationship between Pigouvian commodity taxes and effluent charges. For example, it becomes easy to show that optimal effluent charges function effectively as Pigouvian commodity taxes, but that the implicit tax rates are lower. The geometric treatment would be suitable for use in Intermediate level classes.

Number of Pages in PDF File: 16

Keywords: Externalities, Pigouvian taxes, Effluent charges

JEL Classification: Q50

working papers series