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Pecuniary externality - Wikipedia, the free encyclopedia


Pecuniary externality
From Wikipedia, the free encyclopedia

A pecuniary externality is an externality that operates through prices rather than through real
resource effects. For example, an influx of city-dwellers buying second homes in a rural area can
drive up house prices, making it difficult for young people in the area to get onto the property ladder.
This is in contrast with technological or real externalities which have a direct resource effect on a
third party. For example, pollution from a factory directly harms the environment. Both pecuniary
and real externalities can be either positive or negative.
Under complete markets pecuniary externalities offset each other. For example, if I buy whiskey and
this raises the price of whiskey, the consumers of whiskey will be worse off and the producers of
whiskey will be better off. However, the loss to consumers is precisely offset by the gain to
producers; therefore the resulting equilibrium is still Pareto efficient.[1] As a result, some economists
have suggested that pecuniary externalities are not really externalities and should not be called such.
However, when markets are incomplete or constrained, then pecuniary externalities are relevant for
Pareto efficiency.[2] The reason is that under incomplete markets, the relative marginal utilities of
agents are not equated. Therefore the welfare effects of a price movement on consumers and
producers do not generally offset each other.
This inefficiency is particularly relevant in financial economics. When some agents are subject to
financial constraints, then changes in their net worth or collateral that result from pecuniary
externalities may have first order welfare implications. The free market equilibrium in such an
environment is generally not considered Pareto efficient. This is an important welfare-theoretic
justification for macroprudential regulation.[3][4]
For other recent publications on pecuniary externalities see 'Price, C. (2007) Sustainable forest
management, pecuniary externalities and invisible stakeholders. Forest Policy and Economics 9:
751-762.' An early reference that makes use of this terminology is 'Prest, A. R. and R. Turvey (1965)
Cost-Benefit Analysis: A Survey. The Economic Journal 75: 683-735. The notion of a 'pecuniary
spillover' is also introduced by 'McKean, Roland (1958) Efficiency in Government through Systems
Analysis: With Emphasis on Water Resources Development (John Wiley: New York).' McKean
notes that economists often make a distinction between technological and pecuniary effects, which
may have been true at the time but is not the case today.

1. Jean-Jacques Laffont (2008). "Externalities," The New Palgrave Dictionary of Economics, 2nd Edition.
Abstract. (
2. Bruce Greenwald; Joseph Stiglitz (May 1986). "Externalities in economies with imperfect information
and incomplete markets" (PDF). Quarterly Journal of Economics 101 (2): 229264.
3. Javier Bianchi; Enrique G. Mendoza (June 2010). "Overborrowing, Financial Crises and 'Macroprudential' Taxes" (PDF). NBER Working Paper No. 16091. doi:10.3386/w16091.
4. Olivier Jeanne; Anton Korinek (September 2010). "Managing Credit Booms and Busts: A Pigouvian
Taxation Approach" (PDF). NBER Working Paper No. 16377. doi:10.3386/w16377.