TutorOn by Sanath Withanage

Question:

When a negative externality exists as a result of a production of a good, the socially optimum quantity of output could be achieved by
(1) free market equilibrium.
(2) subsidizing the production of output.
(3) placing limits on the quantity that can be produced.
(4) government purchases of the good.
(5) setting a minimum on the quantity that can be produced.

Correct Answer:

(3)

Answer Explanation:

A negative externality in production means the free market over-produces the good because it ignores social costs (like pollution). To force the market down to the lower, socially optimum quantity, the government must intervene via “command and control” methods (like placing strict production quotas/limits) or imposing a Pigouvian tax.

Topic: Market Failure Year: 2019