Refer to the diagram, in which S is the market supply curve and S1 is a supply curve comprising all costs of production, including external costs. Assume that the number of people affected by these
External costs is large. Without government interference, this market will reach
A) an optimal allocation of society's resources.
B) an underallocation of resources to this product.
C) an overallocation of resources to this product.
D) a higher price than is consistent with an optimal allocation of resources.

Question

Refer to the diagram, in which S is the market supply curve and S1 is a supply curve comprising all costs of production, including external costs. Assume that the number of people affected by these
External costs is large. Without government interference, this market will reach
A) an optimal allocation of society's resources. 
B) an underallocation of resources to this product. 
C) an overallocation of resources to this product. 
D) a higher price than is consistent with an optimal allocation of resources.

Quizplus · Accepted Answer

The presence of external costs means that the market price does not reflect the true cost of production, leading to an overallocation of resources to the product. In other words, the market is producing too much of the product because the external costs are not factored into the price. Therefore, the best choice is C.

Refer to the Diagram, in Which S Is the Market