The agents in a market distorted by an externality should be able to agree on a mutually beneficial way to _________ the gains that could be achieved by altering the market outcome to the Pareto-optimal level.

Question

Quizplus · Accepted Answer

If the externality can be internalized, both parties can benefit from an arrangement where the party causing the externality compensates the other party. Splitting the gains is a mutually beneficial way to ensure both parties gain from the arrangement. Ignoring the externality would mean accepting market inefficiencies, while reducing gains would not provide a mutually satisfactory solution.

The Agents in a Market Distorted by an Externality Should