Multiple Choice
Which of the following is a possible option to address the issue when demand for a good or service exceeds its capacity, resulting in negative externalities?
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7. Externalities
Externalities: Social Benefits and Social Costs
Multiple Choice
Which of the following mitigation tactics could reduce the economic risk associated with negative externalities?
A
Increasing barriers to entry for firms in the market
B
Ignoring the external costs and allowing the market to operate freely
C
Imposing a tax equal to the external cost
D
Subsidizing the production of goods with negative externalities
Verified step by step guidance1
Step 1: Understand what a negative externality is — it occurs when the production or consumption of a good imposes costs on third parties that are not reflected in the market price.
Step 2: Recognize that economic risk from negative externalities arises because the market outcome leads to overproduction or overconsumption of the harmful good, causing social costs.
Step 3: Evaluate each mitigation tactic by considering whether it internalizes the external cost, meaning it makes producers or consumers bear the full social cost of their actions.
Step 4: Analyze why imposing a tax equal to the external cost (a Pigouvian tax) aligns private costs with social costs, thereby reducing overproduction and mitigating the negative externality.
Step 5: Contrast this with other options: increasing barriers to entry may reduce competition but does not directly address external costs; ignoring external costs leaves the problem uncorrected; subsidizing production encourages more of the harmful good, worsening the externality.
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