Refer to the competitive market diagram for product Z. Assume that the current market demand and supply curves for Z are D1 and S1. If there are substantial external beneﬁts associated with the
Production of Z, then
A) government can improve the allocation of resources by subsidizing consumers of Z.
B) government can improve the allocation of resources by imposing a per-unit tax on Z.
C) a government subsidy for producers of Z would ensure that consumers are paying directly for all of the beneﬁts they receive from Z.
D) consumers are paying too much for the good.

Question

Refer to the competitive market diagram for product Z. Assume that the current market demand and supply curves for Z are D1 and S1. If there are substantial external beneﬁts associated with the
Production of Z, then
A) government can improve the allocation of resources by subsidizing consumers of Z. 
B) government can improve the allocation of resources by imposing a per-unit tax on Z. 
C) a government subsidy for producers of Z would ensure that consumers are paying directly for all of the beneﬁts they receive from Z. 
D) consumers are paying too much for the good.

Quizplus · Accepted Answer

If there are substantial external benefits associated with the production of Z, then the social benefit of Z would be greater than the private benefit. This means that the demand curve (D1) does not fully reflect the true value of Z to society. To correct this market failure, the government can subsidize consumers of Z, which would increase the demand for Z and encourage more production. This would result in a new equilibrium point where the quantity produced and consumed is higher than before, and the price for consumers would be lower than it would have been without the subsidy.

Refer to the Competitive Market Diagram for Product Z