The Efficient Production of External Economies

Does independent market adjustment always lead to a less than Pareto optimal supply of goods when there are external economies? The traditional Pigovian conclusion that it did has recently been rejected by some eminent economists. This rejection began with a contribution in this Review by James Buchanan and Milton Kafoglis, who produced examples in which independent market adjustment apparently provided optimal or even supra-optimal supplies of goods with external economies, and thus found the orthodox Pigovian conclusion unsatisfactory. Their finding has been accepted by many economists, including William Baumol, who attempted, in a subsequent communication in this journal, to provide a formal, general explanation of their result. This note will show that Buchanan and Kafoglis failed to call attention to the major theoretical point