Public Finance, 2nd Edition

20

EXTERNALITIES IN A

SECOND-BEST ENVIRONMENT

THE SECOND-BEST ALLOCATION OF SAMUELSONIAN

NONEXCLUSIVE GOODS

Relationships Between First-Best and Second-Best Allocations

Concluding Comment

THE COASE THEOREM, BARGAINING, AND

PRIVATE INFORMATION

Bargaining Set Stability and the Coase Theorem

Private Information

Concluding Comment

We saw in Chapters 6±8 that Wrst-best models of externalities dichotom-

ize in two important respects for policy purposes. One is that the government

can pursue appropriate tax or expenditure policies to restore pareto optim-

ality in the presence of externalities without regard to distributional consider-

ations. All distributional issues are embodied in the interpersonal equity

conditions, which can be satisWed by an appropriate set of lump-sum taxes

and transfers. The other is that externalities arising within a subset of all

goods and factor markets can be corrected independently of behavior in the

other markets, in the sense that the perfectly competitive allocations in these

markets remain pareto optimal. These two properties greatly facilitate policy

design when correcting for externalities.

Unfortunately, neither of these dichotomies holds in a second-best

environment. As a consequence, even the simplest externalities may require

highly complex forms of government intervention, so complex in fact that it

is entirely implausible to expect governments to achieve them. To illustrate

this fundamental point, we will consider the example of providing a Samuel-

sonian nonexclusive consumption good in a many-person economy

made second best because the government does not have the ability to

tax and transfer lump sum to achieve the Wrst-best interpersonal equity

conditions.

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