Externalities in practice
From carbon pricing to congestion charges and antibiotic resistance, externality policies shape modern economies.
Carbon pricing worldwide
According to the World Bank, carbon taxes or emissions trading systems now cover around a quarter of global greenhouse gas emissions. Prices vary widely, from a few dollars to over 100 dollars per tonne. Sweden introduced one of the earliest and highest carbon taxes in 1991 while continuing to grow economically.
Congestion pricing
Each driver entering a crowded city slows others down, a negative externality. Singapore introduced road pricing in 1975; London's congestion charge began in 2003, cutting congestion in the zone at first by around 30%; Stockholm followed in 2007; New York began congestion pricing for lower Manhattan in January 2025.
Plastic bag charges
Small charges on single-use plastic bags have cut their use sharply in many places, often by 80-90%, far more than the small price would suggest. This shows that behavioural responses can be large when a charge makes people notice a habit.
Antibiotic resistance
Each use of antibiotics slightly raises the chance of resistant bacteria, harming future patients: a negative externality. Responses include limiting antibiotic use in farming, prescribing guidelines, and rewards for developing new antibiotics, since the market undervalues drugs held in reserve.
Research and innovation
Ideas spill over: a new invention lets other firms learn and build on it. Because inventors capture only part of the social benefit, markets underinvest in research. Patents, research grants, tax credits, and public universities all aim to correct this positive externality.
Valuing externalities
To set the right tax, economists estimate external costs, such as the social cost of carbon: the damage from one more tonne of carbon dioxide. Estimates depend heavily on assumptions about future damages and how to weigh future generations (the discount rate), so they vary widely and are debated.
Distributional effects
Environmental taxes can fall harder on lower-income households, who spend more of their income on energy. Some countries return carbon tax revenue as equal per-person rebates, which can leave most lower-income households better off while keeping the incentive to cut emissions.
Worked example
A city charges drivers 15 dollars to enter the centre at peak times. Traffic falls 20%, average speeds rise, and buses run more reliably. The revenue funds public transport. Drivers who value the trip most still drive, while others shift times or modes, moving the outcome closer to the efficient level of road use.
Key takeaways
Carbon pricing covers about a quarter of global emissions at widely varying prices. Congestion charges in Singapore, London, Stockholm, and New York reduce traffic. Small charges can change habits dramatically. Antibiotic resistance and research spillovers are major externalities. Setting taxes requires estimating external costs, and revenue recycling can address fairness.
Flashcard
About a quarter of global emissions
Check your understanding
Why might a carbon tax with equal per-person rebates leave many lower-income households better off?