Recall that there are three reasons why a population of strict rational egoists cannot achieve efficient allocations in the absence of moral normative constraints. In Chapter 3, we saw that moral normative constraints are necessary conditions. This reason is sufficient in itself to establish the claim. In Chapter 4, we saw that strict rational egoists cannot institute the required moral rules. In this chapter, I establish that the requisite means to internalize incidental and accidental externalities do not exist under Strict Rational Egoism.

The proof of the First Welfare Theorem in Chapter 2 presupposes that externalities are absent. However, assuming that externalities are absent sets the question of the role of moral normative constraints aside, just as does assuming that every agent behaves competitively. Therefore, we cannot simply assume that externalities are absent. We must determine what normative conditions are required either to preclude or to rectify externalities so as to achieve economic efficiency. To proceed, I first clarify the term externality and distinguish between intentional, accidental, and incidental externalities. I then discuss four roles of moral normative constraints and conventions for eliminating externalities.

Externality

Many theorists have noted that the notions market failure and externality are not well defined. Kenneth Arrow (1969: 133) wrote that “nowhere in the literature does there appear to be a clear general definition of [market failure] or the more general one of ‘externality’.” Andreas A. Papandreou (1994: 2) wrote,