Multiple Choice
Which of the following best describes a reason why countries establish limits on international trade?
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7. Externalities
Public Solutions to Externalities
Multiple Choice
Which of the following is a public solution that governments can use to address externalities and protect economic interests?
A
Allow markets to operate without any intervention
B
Impose taxes or subsidies to internalize external costs or benefits
C
Encourage monopolies to control resource allocation
D
Rely solely on private bargaining between affected parties
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, and these effects are not reflected in market prices.
Recognize that externalities can be either positive (benefits) or negative (costs), and they cause market failures because the market outcome is not socially optimal.
Identify public solutions as government interventions designed to correct these market failures by aligning private incentives with social costs or benefits.
Recall that imposing taxes on activities that generate negative externalities (like pollution) or providing subsidies for activities with positive externalities (like education) helps internalize these external costs or benefits, leading to more efficient market outcomes.
Compare this with other options: allowing markets to operate without intervention ignores externalities, encouraging monopolies can worsen inefficiencies, and relying solely on private bargaining may not be feasible due to transaction costs or information asymmetries.
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