A market economy tends to ________ goods with negative externalities and ________ goods with positive externalities.

Question

Quizplus · Accepted Answer

In a market economy, firms and households make decisions based on their self-interest. When there are negative externalities (costs imposed on third parties), firms and households do not take into account these costs and thus overproduce. For example, driving a car emits pollution which can harm the environment and public health. The cost of pollution is externalized onto society as a whole, but the driver does not incur this cost and thus may drive more than is socially optimal. On the other hand, when there are positive externalities (benefits to third parties), firms and households do not receive the full benefit of their actions and thus underproduce. For instance, getting vaccinated not only benefits the individual but also reduces the spread of disease in the community, benefiting others. The individual may not take this positive externality into account and thus may not get vaccinated as much as is socially optimal. Therefore, a market economy tends to overproduce goods with negative externalities and underproduce goods with positive externalities.

A Market Economy Tends to ________ Goods with Negative Externalities