By bringing to light sources of error in the formulation of both actual and proposed policy, and by helping us to deal with the critical problem of allocative efficiency, externalities theory provides guidance to the practitioner. Part II of this book explores some of the more concrete policy issues to which the analysis can be applied; in doing so, it deals with several topics that have not been the subject of much formal analysis.

But before coming to these applications, we first reexamine the theoretical underpinnings of the analysis. We shall argue in Part I that a number of widely held views about the theory of externalities are unfounded. The analysis also points out several (frequently undetected) booby traps that threaten the unwary in the use of the theory and have significant implications for policy.

We have not tried in this book to provide a comprehensive review of the externalities literature. Because we are interested primarily in materials relevant to the pressing problems attributable to externalities, we have deliberately avoided some of the theoretical issues that have received a great deal of attention. More will be said about these omissions later in this chapter.

Outline of Part I

In Chapter 3, we introduce our treatment of externalities with a nontechnical discussion of the issues and a preview of the major results from the formal analysis. We begin with a definition of externalities and then proceed to some important distinctions among various classes of externalities; here, we differentiate between “technological” and “pecuniary” externalities and those of the “public” and “private” varieties.