Multiple Choice
Which of the following best describes a negative externality in terms of social costs and private costs?
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7. Externalities
Externalities: Social Benefits and Social Costs
Multiple Choice
Which of the following is a sign of market failure due to externalities?
A
Firms produce at the point where marginal cost equals marginal benefit
B
There are no external benefits or external costs
C
The social cost of production exceeds the private cost
D
All benefits and costs are fully reflected in market prices
Verified step by step guidance1
Understand the concept of externalities: Externalities occur when a third party is affected by the production or consumption of a good or service, but these effects are not reflected in market prices.
Define private cost and social cost: Private cost is the cost borne by the producer, while social cost includes both the private cost and any external costs imposed on others.
Recognize that market failure due to externalities happens when the market equilibrium does not account for these external costs or benefits, leading to inefficient allocation of resources.
Identify that if the social cost of production exceeds the private cost, it means negative externalities are present and the market is producing more than the socially optimal quantity.
Conclude that the sign of market failure due to externalities is when the social cost of production exceeds the private cost, indicating that external costs are not internalized by the market.
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