September, 2007

An Economic, Political, and Philosophical Analysis of Externalities

  • Brian Simpson

    Associate Professor of Accounting and Finance, National University
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Externality theory is used to claim that markets fail. It is claimed that because of the existence of externalities, the market will provide too much or too little of a particular good, and that the government must step in and use taxes, subsidies, restrictions on the provision of the good, or take over the production of the good in order to remedy the situation. However, these conclusions do not hold if one performs a comprehensive analysis of externality theory. This essay shows economically, politically, and epistemologically why externality theory does not provide a valid critique of the market. In fact, the essay shows why the market actually succeeds with respect to externalities. Many will be familiar with the economic and political arguments this paper presents; however, by revealing the logical implications of externality theory, this paper provides powerful criticisms of this theory with which few are familiar. Furthermore, the paper goes well beyond politics and economics by providing a fundamental epistemological analysis of externality theory. This latter helps to provide the reader with a complete understanding of the nature of externality theory.

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