Chapter 5, Pigou's Solution Summary and Analysis

The problem for the environment is that the market does not tabulate the costs of damage to the environment. The market only tabulates the costs of production and prices are based on the costs of production. Because of this, free markets are not beneficial to mankind. Gasoline does not include the price of smog, acid rain and other forms of pollution and their effects on humans. These costs are called external costs or spillover effects. In spite of this, free markets represent the form of economic system that is best in creating wealth.

The economy may be operating at an optimal level but there is still destruction of the environment taking place. The destruction occurs because external costs are not a part of the businesses' costs of production. These external costs must somehow be included in the...