Principles for Private and Public Internalisation of Externalities. A Synoptic View

Externalities represent a market failure situation and they appear when one person´s activities influence other person´s welfare in a way that is outside the market mechanism. In contrast to the effects transmitted by market prices, externalities negatively affect the economic efficiency. They arise in everyday life and are noticed only if the effects are obvious. Ronald Coase´s approach started from the premises that externalities can be internalized. His model provides private sector means to defend against market failure. Coase´s solution to internalize externalities based on negotiation between the involved parties, given the property rights, has influenced the free market approach of market failures and today many economists consider that governments should work with the market and not against it using taxes and regulations. In the mainstream literature it is said that if for small local externalities the private sector can find solutions to solve problems, big scale externalities, such as global warming, need government intervention. As far as the last ones are concerned, we can talk about: a) the Pigouvian tax, which is a tax levied on polluting activities; b) the Pigouvian subsidy, given to those who suffer from negative externalities; c) the subsidy paid to individuals or firms to conduct activities with positive externalities; d) legal regulations, such as limits for emitting polluters and restrictions regarding the time of day or year when negative externalities can be legally produced.