In a market with external costs, suppose the efficient level of output is 1,000 units. Which statement is TRUE?
A) To achieve the efficient level of output, the government should set a subsidy equal to the external cost.
B) To achieve the efficient level of output, the government could set a tax equal to the external cost or issue enough tradable allowances to restrict the output to the efficient level.
C) With external costs, the government can use only taxes to achieve the efficient level of output.
D) With external costs, the government can use only tradable allowances to achieve the efficient level of output.

Question

Quizplus · Accepted Answer

When there are external costs, the market equilibrium output will be greater than the efficient level of output. Therefore, to achieve the efficient level of output, the government could set a tax equal to the external cost or issue enough tradable allowances to restrict the output to the efficient level. A subsidy equal to the external cost would encourage more production and increase the externality. Thus, option A is incorrect. Option C and D are incorrect because taxes and tradable allowances can be used interchangeably to achieve the efficient level of output in this scenario.

In a Market with External Costs, Suppose the Efficient Level