Market Mechanisms and the External Benefits of Consumption

Abstract

The consumption or use of a number of goods and services can yield real benefits to nonusers. The consumption of goods yielding external benefits differs from several related phenomena—notably, meritorious behavior, the production and use of public goods, the reduction of negative externalities, and the possibility of consumption surprises. Many goods and services that yield external benefits constitute sets of differentiable substitutes. Furthermore, potential third-party beneficiaries may hold not only diverse preferences for external benefits but also diverse preferences for the alternative goods and services that create these benefits. Finally, markets, if restricted to simple bilateral exchange structures, can mistakenly appear to fail in the case of external benefits. These observations lead to the development of (1) an analytic framework addressing heterogeneous supply and demand and incorporating generalized exchange structures and (2) a typology of market situations for external benefits of consumption that suggests several alternatives to conventional public policies.