Multiple Choice
Contemporary governments promote business development by:
126
views
7. Externalities
Public Solutions to Externalities
Multiple Choice
The government can internalize a negative externality by:
A
eliminating all government intervention in the market
B
subsidizing the production of the good causing the externality
C
imposing a tax equal to the external cost
D
setting a price ceiling on the good
Verified step by step guidance1
Understand what a negative externality is: it occurs when the production or consumption of a good imposes an external cost on third parties not involved in the market transaction.
Recognize that internalizing a negative externality means adjusting the market outcome so that the social cost (private cost plus external cost) is reflected in the decision-making of producers or consumers.
Evaluate each option: eliminating government intervention does not address the external cost; subsidizing production would encourage more of the harmful activity, worsening the externality; setting a price ceiling controls price but does not directly account for external costs.
Identify that imposing a tax equal to the external cost (also called a Pigouvian tax) increases the private cost to producers by the amount of the external cost, aligning private incentives with social costs.
Conclude that the tax effectively internalizes the externality by making producers bear the full social cost, leading to a socially optimal level of production.
