The Greatest Externality Story (N)ever Told

Abstract

This paper criticizes the treatment of externalities presented in modern undergraduate economic textbooks. Despite a tremendous scholarly push-back since 1920 to Pigou’s path-breaking writings, modern textbook authors fail to synthesize important critiques and extensions of externality theory and policy, especially those spawned by Coase. The typical textbook treatment: 1) makes no distinction between pecuniary and technological externalities; 2) is silent about the invisible hand’s unintended and emergent consequences as a positive externality; 3) overemphasizes negative externalities over positive ones; 4) ignores Coase’s critique of Pigouvian tax “solutions;” and 5) ignores the potential relevance of inframarginal external benefits in discussions of policy “solutions” to negative externalities. Aside from presentations of “The Coase Theorem” excerpted from only 4 pages of Coase’s voluminous writings, it is as though the typical textbook author slept through nearly a century of scholarly critique of Pigou.

Keywords: externalities, Pigou, Coase, Coase Theorem, pecuniary, technological, inframarginal, market failure, economic education

JEL Classification: D62, A22