Externalities and the optimal allocation of economic resources

Abstract

The authors consider the problems of influence of externalities on the Pareto optimal allocation of economic resources in the market economy. The analysis of the market equilibrium model in the conditions of competitive market and in case of positive and negative externalities shows a suboptimal allocation of production factors. In case of positive externalities, the equilibrium output is under the socially optimal one, i.e. an optimal solution is obtained. Negative externalities result in output that is bigger than socially optimal, i.e. certain economically unjustified hyperinflation. At the end of the work, the authors draw conclusion that interventions are necessary, both in case of positive and negative externalities, in order to modify individual decisions of market actors to eliminate suboptimal equilibrium states, i.e. suboptimal market strategies.