Question

3) More families are running bed and breakfasts, partially thanks to greater ease in finding customers that websites like vrbo.com provide. Some claim that the increase in bed and breakfasts within neighborhoods create negative externalities on neighbors due to denser traffic flows and more congestion. a) If these claims are true then explain how the quantity of bed and breakfasts determined by the market compares to the socially optimal level of bed and breakfasts. b) Should the government tax or subsidize bed and breakfasts? Whatever policy you choose, please briefly explain how your policy would fix the problem.

Answer 1

Answer - As the greater rise in number of bread and breakfast leads to traffic congestion and inconvinience to neighbourhood , this is example of negative externality. Hence as a result , the market quantity offered by the service providers will be greater than the socially optimal quantity. This is because in this case whole of the economic cost is not be borne by seller. This results in greater than socially optimal level of output.

B - The solution to this is tax and not subsidy. Taxing would increase the cost to the seller , thus result in lesser supply. With the fall in supply , we will reach socially optimal level of output. Subsidy would incentivise the service and hence externality would rise. Hence taxation would be good solution here.