Question

b. A tax can correct for a negative externality and a subsidy to producers can correct for a positive externality because the tax shifts the cost onto firms producing the product, which (Click to select) output, while the subsidy Click to select and Click to select) output.

Answer 1

(a) Spillover costs and spillover benefits are also called negative and positive externalities because:

Option B - the unintended spillover cost has a negative impact on third parties and the unintended spillover benefits have a positive impact on third parties.

Spillover cost is a negative externality that causes a loss or damage to a third party in a market transaction. For example, when a firm releases toxic gases in the air while producing a product, the people living around the factory are affected in terms of inhaling bad air. Spillover benefits is a positive externality that causes a positive impact to a third party while doing something. For example, if a person plants beautiful flowers in his garden, and if that person's neighbour derives satisfaction from that lovely environment then it is a spillover benefit.

(b) A tax can correct for a negative externality and a subsidy to producers can correct for a positive externality because the tax shifts the cost onto firms producing the product which decreases output, while the subsidy increases supply and increases output.

A tax shifts the supply curve towards the left because firms has to bear the cost of the tax which decreases their profit and thus decreases the output. The subsidy on the other hand shifts the supply curve towards the right because firms get money paid by the government to produce more which increases their profit and thus increases the output.