Abstract. An externality exists whenever a transaction creates a cost or a benefit for a party not directly involved. Pollution, such as smoke emitted into the air or sewage poured into the water is an externality. In this paper I analyze the differences between Neo-classical and Austrian School of Economics regarding externalities and the best way to fight it. Neo-classicals are concerned about efficiency and they propose some forms of government intervention in order to alleviate pollution: taxes and tradable permits. Austrians seek to remove interpersonal conflict related to pollution and show that although taxes and permits could theoretically work, they fail to eliminate conflicts among people.

Keywords: externality; pollution; property rights; neo-classical economics; Austrian economics.