Externalities and fundamental nonconvexities: A reconciliation of approaches to general equilibrium externality modeling and implications for decentralization

Starrett (1972) [33] and Boyd and Conley (1997) [7] approaches to externality modeling are unified by distinguishing between producible and nonproducible public commodities. Nonconvexities are associated with detrimental producible public commodities but not with nonproducible public commodities in Boyd and Conley (1997) [7]. Disposability properties (costly or costless) imply that producible public commodities are either by-products (e.g., pollution) or joint-products (e.g., national defense). Markets fail for both beneficial and detrimental by-products. Nonconvexities imply that price-based equilibria, e.g., Pigovian tax equilibrium, may not be Pareto-efficient. Foley's (1967, 1970) [17] and [18] “public competitive equilibrium” combines price and quantity signals with a unanimity criterion and restores the equivalence between equilibrium and efficiency.