Question

The fact that market outcomes fail to achieve Pareto efficiency in the case of ______, implies that ______.

1. externality; government regulation is necessary
2. natural monopoly; private property rights are unethical
3. public goods; government action may improve the allocation of resources
4. public goods; government must maximize income tax revenues

Answer 1

Correct option is (A).

A positive externality exists when actions by one economic agent gives rise to benefits to other economic agents, for which they do not pay. Unless externalized, market outcome in presence of positive externality leads to underproduction, leading to market failure. In this case, government intervention in the form of subsidy can correct the failure.

A negative externality exists when actions by one economic agent gives rise to costs for other economic agents, for which they are not compensated. Unless externalized, market outcome in presence of negative externality leads to overproduction, leading to market failure. In this case, government intervention in the form of tax can correct the failure.