Question

Consider the case of a good with external benefits. If you plant trees in front of your house, the neighborhood is more attractive, and trees create shade, provide oxygen, and a home for birds and squirrels. Thus, the benefits to society are greater than the benefits to you. If the planting of trees is a private choice, you will plant ( the right number / too few / too many ) trees relative to the socially optimal quantity, because the private value to you is ( less than / equal to / more than ) the social value.

Which of the following would help to correct this problem?

- Do nothing, because government interference cannot improve the situation.

- Subsidize the planting of trees.

- Tax the planting of trees.

- Prohibit the planting of trees.

Answer 1

If a good creates positive externality then private benefits from the good are less than the social benefits from the good.

In such scenario, private producer tends to produce quantity of good that is lower than the socially optimal quantity.

So,

If the planting of trees is a private choice, you will plant too few trees relative to the socially optimal quantity, because the private value to you is less than the social value.

This problem can be corrected through subsidizing of the planting of trees by private individuals as such subsidy will increase private benefits and will lead to achievement of socially optimal quantity of trees being planted.

Hence, the correct answer is the option (2).