Suppose that a negative externality creates $1 billion worth of costs to third parties. The government attacks the problem with regulations that cut the cost of the externality to $500 million but cost business and consumers $1.5 billion. This situation illustrates the idea that:
A) regulations are an effective way to curb externalities.
B) externalities can never be corrected.
C) correcting market failure can result in government failure.
D) getting rid of externalities requires a great deal of necessary sacrifice for all of us.

Question

Quizplus · Accepted Answer

The situation illustrates government failure because the cost of the regulation ($1.5 billion) exceeds the benefit of reducing the externality ($500 million), leading to an inefficient outcome.

Suppose That a Negative Externality Creates $1 Billion Worth of Costs