Multiple Choice
In the context of public solutions to externalities, what is it called when the government controls business behavior through rules or laws?
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7. Externalities
Public Solutions to Externalities
Multiple Choice
Which of the following is a public policy a European government could implement to address negative externalities from trade?
A
Encourage monopolies in the affected industries
B
Subsidize the production of goods with negative externalities
C
Impose a tax on goods that generate negative externalities
D
Eliminate all regulations on international trade
Verified step by step guidance1
Understand what a negative externality is: it occurs when the production or consumption of a good causes a cost to a third party that is not reflected in the market price.
Recognize that public policies aim to correct market failures caused by negative externalities by internalizing these external costs.
Evaluate each option in terms of how it affects the externality: encouraging monopolies or subsidizing production typically do not internalize external costs and may worsen the problem.
Recall that imposing a tax on goods that generate negative externalities (often called a Pigovian tax) increases the cost of producing or consuming those goods, aligning private costs with social costs.
Conclude that eliminating all regulations would likely remove controls that mitigate negative externalities, so it is not an effective policy to address them.
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