Sometimes the problem of externalit

Sometimes the problem of externalities is solved with moral codes and social
sanctions. Consider, for instance, why most people do not litter. Although there
are laws against littering, these laws are not vigorously enforced. Most people
do not litter just because it is the wrong thing to do. The Golden Rule taught to
most children says, “Do unto others as you would have them do unto you.” This
moral injunction tells us to take account of how our actions affect other people. In
economic terms, it tells us to internalize externalities.
Another private solution to externalities is charities, many of which are estab-lished to deal with externalities. For example, the Sierra Club, whose goal is to
protect the environment, is a nonprofit organization funded with private dona-tions. As another example, colleges and universities receive gifts from alumni, cor-porations, and foundations in part because education has positive externalities for
society. The government encourages this private solution to externalities through
the tax system by allowing an income tax deduction for charitable donations.
The private market can often solve the problem of externalities by relying on
the self-interest of the relevant parties. Sometimes the solution takes the form of
integrating different types of businesses. For example, consider an apple grower
and a beekeeper who are located next to each other. Each business confers a
positive externality on the other: By pollinating the flowers on the trees, the bees
help the orchard produce apples. At the same time, the bees use the nectar they
get from the apple trees to produce honey. Nonetheless, when the apple grower
is deciding how many trees to plant and the beekeeper is deciding how many
bees to keep, they neglect the positive externality. As a result, the apple grower
plants too few trees and the beekeeper keeps too few bees. These externalities
could be internalized if the beekeeper bought the apple orchard or if the apple
grower bought the beehives: Both activities would then take place within the
same firm, and this single firm could choose the optimal number of trees and bees.
Internalizing externalities is one reason that some firms are involved in different
types of businesses.
Another way for the private market to deal with external effects is for the inter-ested parties to enter into a contract. In the foregoing example, a contract between
the apple grower and the beekeeper can solve the problem of too few trees and
too few bees. The contract can specify the number of trees, the number of bees,
and perhaps a payment from one party to the other. By setting the right number
of trees and bees, the contract can solve the inefficiency that normally arises from
these externalities and make both parties better off.