Refer to the provided supply and demand graph for a product. In the graph, line S is the current supply of this product, while line S1 is the optimal supply from the society's perspective. One
Solution to this externality problem is to
A) give consumers a subsidy of the amount FG per unit.
B) give producers a subsidy of the amount AB per unit.
C) tax producers by the amount DE per unit.
D) tax consumers by the amount EF per unit.

Question

Refer to the provided supply and demand graph for a product. In the graph, line S is the current supply of this product, while line S1 is the optimal supply from the society's perspective. One
Solution to this externality problem is to
A) give consumers a subsidy of the amount FG per unit. 
B) give producers a subsidy of the amount AB per unit. 
C) tax producers by the amount DE per unit. 
D) tax consumers by the amount EF per unit.

Quizplus · Accepted Answer

The gap between the optimal supply from the society's perspective (S1) and the current supply (S) represents a negative externality, where the cost to society is greater than the cost to producers. A tax on producers by the amount DE per unit would increase the cost to producers, making it less profitable to supply the product at the current quantity, and shifting the supply curve leftward towards the optimal quantity. This would incentivize producers to reduce output, which would decrease the negative externality and lead to a more efficient outcome for society. A subsidy to consumers or producers would increase output and exacerbate the negative externality, while a tax on consumers would decrease demand and lead to a lower equilibrium quantity.

Refer to the Provided Supply and Demand Graph for a Product