A Market Based Solution to Price Externalities: A Generalized Framework

Weerachart T. Kilenthong
Robert M. Townsend
Publication Type: 
Working Papers
Publication Article File: 
Publication Year: 

Pecuniary externalities have regained the interest of researchers as they seek policy interventions and regulations to remedy externality-induced distortions, e.g., balance sheet effects, amplifiers and fire sales. We show how bundling, exclusivity and additional markets internalize these pecuniary externalities; ex ante competition can achieve a constrained-efficient allocation. We cover a large variety of example economies which differ from one another in the particular source of the constraint generating the externality. We do not need to identify and quantify some policy intervention. With the appropriate ex ante design we can let markets solve the problem.

Economic Modeling
General Equilibrium