Multiple Choice
Economic sanctions against foreign governments sometimes create externalities because:
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7. Externalities
Externalities: Social Benefits and Social Costs
Multiple Choice
The most efficient way to ensure that producers are responsible for the social costs of their products is through:
A
Allowing the market to operate without intervention
B
Setting a price ceiling on the product
C
Providing subsidies to producers
D
Imposing a Pigovian tax equal to the external cost
Verified step by step guidance1
Understand the concept of externalities: External costs occur when the production or consumption of a good imposes costs on third parties not involved in the transaction, leading to market failure.
Recognize that allowing the market to operate without intervention often results in overproduction of goods with negative externalities because producers do not bear the full social cost.
Know that setting a price ceiling or providing subsidies does not internalize the external cost; price ceilings can cause shortages, and subsidies may encourage more production, worsening the externality.
Learn that a Pigovian tax is designed to equal the external cost per unit of the good, effectively making producers pay for the social cost they impose, aligning private costs with social costs.
Conclude that imposing a Pigovian tax corrects the market failure by reducing production to the socially optimal level, ensuring producers are responsible for the external costs of their products.
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