Chapter 14R, Problem 3MCQ

To determine

The correct option which leads to the socially optimal quantity of output when the production of a good creates negative externalities

Answer to Problem 3MCQ

From the available options, the correct option is a Pigouvian tax set equal to the marginal external cost.

Explanation of Solution

In the case of negative externalities, a Pigouvian tax for a good would be equal to the marginal external cost that is incurred by consuming or using one extra unit because a negative externality exists when the production of one extra unit of the commodity has a negative impact on the third party. Whereas, external benefit indicates the Pigouvian subsidy, not costs which means this options d, b, and a for negative externality is not correct. Average cost pricing does not have any impact from negative externalities therefore, option, e is incorrect.

Here, the correct option is c (a Pigouvian tax set equal to the marginal external cost).

Economics Concept Introduction

Introduction: Externality problems such as pollution refer to the fundamental economic policy problems while firms do not internalize the indirect costs or indirect benefits from any of their economic transactions in the market.