Chapters in Books
Abstract:
INTRODUCTION The idea that the pursuit of private interests may not redound to the larger social interest has a long history in economic thinking, but it was not until the second half of the 19th century that this line of thought began to coalesce into an analysis of market failure. The first stage of this process culminated in A. C. Pigou’s analysis of private and social net products, beginning with his Wealth and Welfare and then, more expansively, in The Economics of Welfare. The Economics of Welfare, in turn, laid the foundation for the second stage: the development of the orthodox theory of market failure in the middle third of the 20th century. Indeed, Pigou’s work has been cited by supporters and critics alike as the basis for a neoclassical approach to market failures that dominated economic thinking from the 1940s onward. The resulting advances showed the restrictive nature of the conditions for optimality and, as a result, the pervasiveness of market failure. With this came demonstrations of how governmental policies could be put in place to achieve optimality. The last third of the century witnessed a series of challenges to this received view, catalyzed by the Chicago and Virginia schools. The work of James Buchanan, Ronald Coase, Milton Friedman, Robert Lucas, George Stigler, and Gordon Tullock both challenged the traditional view and led to a larger reexamination by economists of the relations between state and economy at both the micro and macro levels.