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A Teaching Topic in Economic Analysis 


Externalities occur when an individual firm’s decision brings either costs or benefits to third party stakeholders (Toronto PPG 1002H). This topic explores externalities as an important cause of Pareto inefficient outcomes and thus market failures. It identifies poorly defined property rights as the main source of these market failures. Clearly defining property rights, when possible, is understood to be a solution to achieve Pareto efficient outcomes. Both positive and negative externalities are explored, as are consumption and production externalities.

Topic Learning Outcome: Appropriately utilize and interpret results of applying the lens of externalities to the analysis of public policy and management problems. 

Core Concepts associated with this Topic: Coase Theorem, Externalities, Opportunity Cost

Recommended Reading

University of Toronto: PPG-1002

Varian, Hal R., and Jack Repcheck. Intermediate microeconomics: a modern approach. Vol. 6. New York, NY: WW Norton & Company, 2010. Chapter 34 (p. 645-667).

Harvard Kennedy School: API-101

Pindyck, Robert S. and Daniel L. Rubinfeld. Microeconomics, 8th Edition. Prentice-Hall, 2012. Chapter 18 (661-690).

NYU Wagner: GP-1018

Mankiw, N. Gregory. Principles of Microeconomics, 6th edition. Mason: South-Western College Publishers, 2011. Chapter 10.

Johnson-Shoyama: JS-805

Krugman, Paul, Robin Wells, and Anthony Myatt. Microeconomics: 1st Canadian Edition. London: Worth Publishers, 2006. Chapters 18 - 20.

George Washington: PPPA-6003

Mankiw, N. Gregory. Principles of Microeconomics, 6th edition. Mason: South-Western College Publishers, 2011. Chapters 10 and 11.

Wheelan, Charles. Naked Economics: Undressing the Dismal Science. New York: W. W. Norton& Company, 2010. Chapter 3.

American: PAUD-630

Krugman, Paul and R. Wells, Microeconomics, 3rd edition. London: Worth Publishers, 2012. Chapter 16.

Rutgers: Economics in Public Policy

Pindyck, Robert S., and D. Rubinfeld. Microeconomics, 7th edition.  Upper Saddle River: Patience-Hall, 2007. Chapter 18.

Coase, Ronald. "The Problem of Social Cost." Journal of Law and Economics 3 (1960): 1-44.


Sample Assessment Questions:

1.) What are externalities, and how do they produce outcomes that are not Pareto inefficient?

2.) Why is the clear delineation of property rights important for minimizing the negative impacts of externalities/

3.) What is a pigouvian tax?

4.) Identify one area of public policy where externalities create a sub-optimal outcome, requiring (in at least the minds of some) a public policy response. Describe one situation in which externalities contribute to market failure, and at least one policy tool that could be employed in response.

Page updated by Sean Goertzen and Ben Eisen on 16 April 2015.


Important Notices
© University of Toronto 2008
School of Public Policy and Governance