Learning Path
Question & Answer1
Understand Question2
Review Options3
Learn Explanation4
Explore TopicChoose the Best Answer
A
Externalities always lead to market failure, requiring government intervention.
B
Social optimum occurs when marginal social cost equals marginal social benefit.
C
Private costs are always aligned with social costs in the presence of externalities.
D
Addressing externalities can lead to an increase in overall social welfare.
E
The existence of positive externalities can justify government subsidies.
Understanding the Answer
Let's break down why this is correct
Answer
When a good creates a positive or negative externality, the private price that buyers and sellers see is different from the true cost or benefit to society, so the market quantity is not the social optimum. Because of this mismatch, the market will either overproduce (negative externality) or underproduce (positive externality) compared to what is best for everyone. To reach the social optimum, the external cost or benefit must be added to or subtracted from the private price, which can be done by taxes, subsidies, or regulation. For example, if a factory pollutes the air, the market will produce more units than the socially optimal amount; a tax equal to the pollution cost can reduce output to the socially optimal level.
Detailed Explanation
A social optimum is reached when the extra benefit from a good equals the extra cost to society, so the marginal social benefit must equal the marginal social cost. Other options are incorrect because The idea that every externality forces a government fix is a common mistake; People often think private costs and social costs always match, but externalities create a gap.
Key Concepts
Externalities
Social Optimum
Market Efficiency
Topic
Externalities and Social Optimum
Difficulty
hard level question
Cognitive Level
understand
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