External benefits can drive a wedge between the _______ and the _______ resulting in a market failure.

Question

Quizplus · Accepted Answer

External benefits refer to the positive effects that a transaction or activity can have on individuals or society as a whole, but that are not accounted for in the market price. In other words, these benefits are not reflected in the private marginal WTP (willingness to pay) curve of the consumers and producers involved in the transaction.

As a result, external benefits tend to push the social marginal WTP curve above the market demand curve, creating a gap or wedge between the two curves. This gap represents the value of the external benefits that are being neglected by the market participants.

This wedge can lead to a market failure because it means that the market outcome is not socially efficient. In particular, the market quantity will be lower than the socially optimal quantity, and the price will be lower than the socially optimal price. This is because the market ignores the positive effects of the transaction on third parties or society as a whole, and therefore tends to underproduce the good or service in question.

Therefore, external benefits can drive a wedge between the market demand curve and the social marginal WTP curve, resulting in a market failure. Choice B is the best answer as it captures this idea.

External Benefits Can Drive a Wedge Between the _______ and the _______

External Benefits Can Drive a Wedge Between the _ and the _