Multiple Choice
Which of the following is something the federal government is generally forbidden to do when addressing externalities?
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7. Externalities
Public Solutions to Externalities
Multiple Choice
Which of the following is a public solution to address negative externalities in a market economy?
A
Allowing firms to self-regulate without government intervention
B
Increasing subsidies for the production of goods with negative externalities
C
Imposing a Pigovian tax on the activity causing the externality
D
Encouraging voluntary agreements among private parties
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 a public solution involves government intervention to correct the market failure caused by the negative externality.
Identify that allowing firms to self-regulate or encouraging voluntary agreements are private solutions, not public ones.
Know that increasing subsidies for goods with negative externalities would worsen the problem by encouraging more of the harmful activity.
Understand that imposing a Pigovian tax is a classic public policy tool designed to internalize the external cost by taxing the activity causing the negative externality, thereby aligning private costs with social costs.
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