Externalities and Compensation: Primeval Games and Solutions

Abstract

The classical literature (Pigou (1920), Coase (1960), Arrow (1970)) and the relatively recent studies (cf.Varian (1994)) associate the externality problem with efficiency.This paper focuses explicitly on the compensation problem in the context of externalities.To capture the features of inter-individual externalities, this paper constructs a new game-theoretic framework: primeval games.These games are used to design normative compensation rules for the underlying compensation problems: the marginalistic rule, the concession rule, and the primeval rule.Characterizations of the marginalistic rule and the concession rule are provided and specific properties of the primeval rule are studied.externality;compensation;primeval games;marginalistic rule;concession rule;primeval rule