Question

Explain the impact of external costs and external benefits on resource allocation.

Answer 1

Resource means factors of production, such as land, labor, capital, etc. If the resource allocation is high, there would be higher production. If such allocation is low, production would be low.

At higher price, market supply would be high although it increases external cost like pollution cost, health cost, etc. It indicates over-allocation of resources, and such thing happens when there is no government restriction.

Once the society starts suffering, the government restriction should come into play, which reduces production. Therefore, increasing the external cost reduces resource allocation at the government restriction.

All sorts of positive externalities are external benefits; if it increases the production would be at lower side. Therefore, external benefits are the cause of under-allocation of resources.