June 29, 2011
In economic activity, there are sometimes 'externalities' or spillover effects to other people not involved in the original exchange. Positive externalities result in beneficial outcomes for others, but negative externalities impose costs on others. Prof. Sean Mullholland addresses a classic example of a negative externality, pollution, and describes three possible solutions for the problem: taxation, government regulation, and property rights. The first two options are difficult to monitor and may create perverse incentives. A better solution to overcome the externality is property rights, as described by Ronald Coase. As long as property rights are well-defined, divisible, and defendable, parties can negotiate to reduce the impact of the pollution.