The residual character of externalities

Abstract

This paper claims that the term ‘externality’ designates a residual entity that corresponds to what is left aside by the market. Fluctuations in the importance granted to externalities reflect fluctuations in the place granted to the market. In the first half of the twentieth century, externalities were judged unimportant. Later, they became pervasive. This radically changed in the 1960s through a redefinition of the market largely based on Ronald Coase's views on transaction costs. The paper analyses these fluctuations in the economists' understanding of externalities and proposes a way of clearly distinguishing externalities from what is internal to the market.