Negative externalities, environmental quality and the transformation space

The purpose of this paper is to analyze the properties of the transformation space of an economy with private goods, environmental quality, and negative externalities. The property of the transformation space determines the level of permissible decentralization [Laffont]. If nonconvexities prevail, only milder forms of decentralization (such as taxation instead of artifical markets) are permitted for optimal allocation results; or, as Baumol/Oates [1975, p. 103] point out, “prices may give the wrong signals — directing the economy away from the social optimum.”