Externalities, Fixed Costs and Information

The well-known theoretical solutions to the problem of externalities developed by Arthur C. Pigou and Ronald H. Coase--taxation according to measured preferences, bargaining under low transaction costs--have restated the problem of social cost, rather than addressed it: externalities exist where preferences are difficult to measure and transaction costs are high. Building on Kenneth J. Arrow's conjecture that the existence of externalities is equivalent to the nonexistence of markets, the article demonstrates that externalities are characterized by informational complexity and high transaction costs. As an appropriate response capable of addressing the complexity and the dynamic nature of externalities, institution-based approaches are presented. Copyright 1998 by WWZ and Helbing & Lichtenhahn Verlag AG