Multiple Choice
How can government regulation addressing externalities affect a producer's output decisions?
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7. Externalities
Externalities: Social Benefits and Social Costs
Multiple Choice
Which of the following statements is true about the effects of externalities on social benefits and social costs?
A
Negative externalities increase the social benefit above the private benefit.
B
Negative externalities cause the social cost to exceed the private cost.
C
Positive externalities reduce the social benefit below the private benefit.
D
Positive externalities cause the social cost to be less than the private cost.
Verified step by step guidance1
Step 1: Understand the concept of externalities. Externalities occur when a third party is affected by the production or consumption of a good or service, and these effects are not reflected in market prices.
Step 2: Define private and social costs and benefits. Private cost/benefit refers to the cost/benefit borne by the producer or consumer directly involved, while social cost/benefit includes both private costs/benefits and any external costs/benefits imposed on or received by third parties.
Step 3: Analyze negative externalities. Negative externalities impose additional costs on society beyond the private cost, so social cost is greater than private cost. This means the market outcome leads to overproduction relative to the socially optimal level.
Step 4: Analyze positive externalities. Positive externalities provide additional benefits to society beyond the private benefit, so social benefit is greater than private benefit. This means the market outcome leads to underproduction relative to the socially optimal level.
Step 5: Evaluate the given statements based on these definitions: Negative externalities increase social cost above private cost (true), and positive externalities increase social benefit above private benefit (true). Therefore, statements claiming the opposite are false.
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