Pecuniary externalities
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A pecuniary externality occurs when the actions of an
economic agent In economics, an agent is an actor (more specifically, a decision maker) in a model of some aspect of the economy. Typically, every agent makes decisions by solving a well- or ill-defined optimization or choice problem. For example, ''buyers'' (c ...
cause an increase or decrease in market prices. 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 buy a house. The
externality In economics, an externality or external cost is an indirect cost or benefit to an uninvolved third party that arises as an effect of another party's (or parties') activity. Externalities can be considered as unpriced goods involved in either co ...
operates through prices rather than through real resource effects. This is in contrast with technological or real externalities that have a direct resource effect on a third party. For example, pollution from a factory directly harms the environment. As with real externalities, pecuniary externalities can be either positive (favorable, as when consumers face a lower price) or negative (unfavorable, as when they face a higher price). The distinction between pecuniary and technological externalities was originally introduced by Jacob Viner, who did not use the term ''externalities'' explicitly but distinguished between ''economies'' (positive externalities) and ''diseconomies'' (negative externalities). Under complete markets, pecuniary externalities offset each other. For example, if someone buys whiskey and this raises the price of whiskey, the other 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. 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. 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 In mathematics and other formal sciences, first-order or first order most often means either: * "linear" (a polynomial of degree at most one), as in first-order approximation and other calculus uses, where it is contrasted with "polynomials of high ...
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 that may require the introduction of targeted policy tools.
Roland McKean Roland Neely McKean (October 30, 1917 – April 15, 1993) is an American economist. He received his A.B. and Ph.D. degrees in economics from the University of Chicago. From 1951 to 1963, he was a research economist at the RAND Corporation, whe ...
was the first to distinguish technological and pecuniary effects.


References


External links


Steve Landsburg's ''The Tragedy of the Chametz''
{{DEFAULTSORT:Pecuniary Externality Pricing