Question

Refer to the following supply and demnd graph. This is ________ externality which can be corrected to the optimal level with a _______.

a. positive, tax

b. negative, subsidy

c. negative, tax

d. positive, subsidy

Price S2 Si Q: Q2 Quantity

Answer 1

Ans) Externality is when the bystander bears the cost or benefit of any activity. It is of two types ÷ positive and negative.

Positive externality is when the bystander bears the benefit of any activity. Here marginal social benefit is more than marginal private benefit. The difference between social benefit and private benefit is known as external benefit. When this external benefit is ignored, goods are underproduced. To internalise this externality government gives subsidy equal to external benefit. Eg- education.

external benefit social benefit private benefit Qmarket Qefficient

Negative externality is when the bystander bears the cost of any activity. Here marginal social cost is more than marginal private cost. The difference between social cost and private cost is known as external cost. When this external cost is ignored, goods are overproduced. To internalise this externality, government imposes tax equal to external cost. Eg- pollution.

external cost Qefficient Qmarket

Here, S1 is marginal private cost while S2 is marginal social cost. So it is negative externality. Government will impose tax to internalise this externality.

Option c.