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Edited by André de Palma, Robin Lindsey, Emile Quinet and Roger Vickerman
Chapter 14: Theory of External Costs
14 Theory of external costs Stef Proost INTRODUCTION This chapter explores the concept and use of external costs in transport economics. External costs of transport are real costs that are not included in the market price of transport and are therefore not borne by the user. This covers a wide range of problems: airport noise, air pollution by cars and trucks, car accidents, road congestion and so forth. External costs are considered an important market failure. This means that government intervention (taxes, regulations and so forth) could improve the unregulated market outcome. Neither the exact magnitude of the external costs, nor the best policy intervention are easy to determine. For this reason, external costs have been at the origin of fierce policy debates, ranging from the introduction or not of congestion pricing to the promotion of electric vehicles and speed limits on highways. In this chapter we return to the basics. What is an external cost, why does it exist in a market economy, is there any difference between external costs generated by producers (trucks) and consumers (cars), how do external costs interact with the other market failures (income distribution, revenue raising taxes) and what does this imply in terms of policy instruments? According to Laffont (2008), the discussion of external costs took off really with Pigou (1920). Coase (1960) has shown how external costs are dealt with in the small number case by negotiation and contracts. Samuelson (1954) has shown how external costs and public bads affect the properties...
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