Multiple Choice
Which of the following is an example of a negative externality that can adversely affect a firm's operations?
94
views
7. Externalities
Externalities: Social Benefits and Social Costs
Multiple Choice
In a market with negative externalities, the market will tend to:
A
produce more than the socially optimal quantity
B
produce less than the socially optimal quantity
C
set prices equal to marginal social cost
D
internalize all external costs without intervention
Verified step by step guidance1
Step 1: Understand what a negative externality is. A negative externality occurs when the production or consumption of a good causes a cost to a third party that is not reflected in the market price. For example, pollution from a factory affects people who are not involved in the transaction.
Step 2: Recognize that in the presence of a negative externality, the private marginal cost (PMC) of producing a good is less than the social marginal cost (SMC), because the external costs are not included in the producer's costs.
Step 3: Recall that the market equilibrium quantity is determined where the demand curve equals the private marginal cost (PMC), not the social marginal cost (SMC). This means the market equilibrium quantity is higher than the socially optimal quantity, which would be where demand equals SMC.
Step 4: Understand that because the market does not account for the external costs, it tends to produce more than the socially optimal quantity, leading to overproduction and welfare loss.
Step 5: Conclude that without intervention, the market fails to internalize the external costs, resulting in a quantity produced that is greater than the socially optimal level.
Related Videos
Related Practice
