Multiple Choice
Which of the following is NOT a public solution to externalities?
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7. Externalities
Public Solutions to Externalities
Multiple Choice
Which of the following is a public policy that a government can implement to address negative externalities in a free-market economy?
A
Subsidizing the production of goods that generate negative externalities
B
Eliminating all government regulations on market activities
C
Setting price floors for goods with negative externalities
D
Imposing a tax equal to the external cost on producers
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 in a free-market economy, negative externalities lead to overproduction or overconsumption of the harmful good because producers do not bear the full social cost.
Identify that a government policy to correct this market failure should internalize the external cost, meaning the producer should face the full social cost of production.
Know that imposing a tax equal to the external cost on producers (also called a Pigovian tax) increases the private cost to match the social cost, reducing the quantity produced to a socially optimal level.
Evaluate other options: subsidizing production would worsen the problem, eliminating regulations removes controls, and price floors typically increase prices but do not directly address external costs.
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