Pecuniary externality
A pecuniary externality occurs when the actions of an economic agent 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 operates through prices rather than through real resource effects.
This is in contrast with technological or real
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).[1]
Under
However, when markets are incomplete or constrained, then pecuniary externalities are relevant for Pareto efficiency.[3] 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 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.[4][5][6]
Roland McKean was the first to distinguish technological and pecuniary effects.[7]
References
- ^ Jacob Viner (1932) "Cost Curves and Supply Curves", Journal of Economics, vol. 3, pp. 23-46.
- ^ Jean-Jacques Laffont (2008). "Externalities," The New Palgrave Dictionary of Economics, 2nd Edition. Abstract.
- JSTOR 1891114.
- doi:10.3386/w16091.
- ^ Enrico Perotti; Javier Suarez (December 2011). "A Pigouvian Approach to Liquidity Regulation". International Journal of Central Banking.
- doi:10.3386/w16377.
- ISSN 0079-7723.