Abstract Summary
Rebecca Livernois (University of British Columbia) - An externality in economics is broadly defined as an unpriced spillover effect between agents. There is little consensus, however, among economists or philosophers on a more precise characterization of the term (Arrow 1969; Meade 1952; Berta 2017; Lagueux 2010; Papandreou 1994). In this paper, I offer a clarification of the concept of an externality and argue that the bridging conditions are unclear when forging policies. An externality is modelled in a multi-agent optimization framework where an unpriced activity taken by one agent affects another agent. In this model, an externality is a case of untapped gains from exchange. That is, it occurs when an agent’s willingness to pay for a reduction in the unpriced activity diverges from another agent’s willingness to accept a payment for the reduction. Unlike an externality in the model where agents have perfect information, however, externalities in the world are invariably accompanied by imperfect information. As a result, it is unclear whether the willingness to pay in the world that constitutes an externality refers to an agent’s actual willingness to pay for an activity or an agent’s willingness to pay conditional on their having true beliefs about the activity. I argue that both interpretations are problematic. As such, it is unclear how to interpret an externality when applied in specific policies such as a carbon tax.
