Question

If the production of a product or service involves external costs (a negative externality), then the...

If the production of a product or service involves external costs (a negative externality), then the government can improve efficiency in the market by:

a) Providing a subsidy to correct for an underallocation of resources

b) Imposing a corrective tax to correct for an underallocation of resources

c) Imposing a corrective tax to correct for an overallocation of resources

d) Providing a subsidy to correct for a an overallocation of resources

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Answer #1

c) Imposing a corrective tax to correct for an overallocation of resources

An external cost be reduced by the taxing the production and providing solution from the solution to the external cost effect will be in equilibrium at private benefit equal to the social cost of the production, where social cost =external cost+private costs; and the tax reduces the overproduction of the good which is causing a higher social costs.

A subsidy is used to correct under allocation of external benefits.

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