Our authors devote Chapter 7 to a discussion of the conflicts that surround externalities in urban environments. As argued in previous chapters, externalities arise because of ill-defined property rights, incomplete information, and a public domain that is vulnerable to wasteful competitive behavior. Our authors outline four basic problems: (i) externalities mean unexploited gains from trade, (ii) lead to wasteful competition costs, (iii) impose their own transaction and third-party costs, and (iv) give rise to moral issues, such as the problems of unsustainable consumption.

Our authors argue that any approach taken to address externalities involves a value judgment. With this in mind, they discuss five possible approaches to tackling them:

1) Do nothing : this strategy only works where costs remain within certain bounds.

2) Voluntary solutions such as negotiation, mediation, litigation or unitization : these tactics can help solve some externality problems, especially with a small group of stakeholders.

3) Information and persuasion : urban plans that give signals to developers and investors are one example. This is also useful in campaigns to reduce consumer behavior which has high social costs, like smoking or unsafe driving.

4) Direct investment: investment in roads or other infrastructure. Very little discussion is offered; the authors merely suggest that most externality problems required more sophisticated management.

5) Subsidization of transaction costs: by lowering the transaction costs that inhibit negotiated settlement, investment in mediation or arbitration services may lead to more voluntary solutions. The authors suggest that this subsidy approach is an underutilized tactic that may warrant more research.

Webster and Lai proceed with an analysis of fiscal approaches to abating externalities. These approaches include taxing the polluter, subsidizing the polluter, subsidizing the polluted party, and taxing the polluted party. The authors argue that all these fiscal methods are a way of redistributing ownership and liability between the polluter and the polluted. However, taxes and regulations can have different outcomes for the different groups involved, depending on which method is used. The authors argue that producers may prefer regulations because they often serve to stifle competition. Webster and Lai also argue that both producers and consumers can benefit from tradable quotas, whereas central governments typically prefer taxation.