According to Pigovian analysis,competitive behavior will result in overproduction of a good when
A) firms' activities create external costs.
B) people outside of market transactions benefit from those transactions.
C) property rights have been clearly and unambiguously assigned.
D) private and social marginal costs are identical.

Question

Quizplus · Accepted Answer

Pigovian analysis focuses on the presence of externalities, which occur when a market transaction affects people outside of that transaction. When firms' activities create external costs (such as pollution), the private marginal cost of production is less than the social marginal cost (which includes the cost of the externalities). In a competitive market, firms will produce up to the point where the private marginal cost equals the market price, but this will result in overproduction from a social perspective since the social marginal cost is greater. Therefore, intervention is needed to correct this market failure, such as a Pigovian tax to internalize the external cost. Choices B, C, and D are not directly related to the issue of externalities and overproduction.

According to Pigovian Analysis,competitive Behavior Will Result in Overproduction of a Good