When externalities exist, buyers and sellers:
A) neglect the external effects of their actions but the market equilibrium is still efficient
B) neglect the external effects of their actions and the market equilibrium is not efficient
C) do not neglect the external effects of their actions and the market equilibrium is efficient
D) do not neglect the external effects of their actions and the market equilibrium is not efficient

Question

Quizplus · Accepted Answer

When externalities exist, buyers and sellers do not consider the external effects of their actions, resulting in the market equilibrium being inefficient. This is because the prices charged and quantities exchanged do not reflect the full social costs or benefits associated with a transaction. For example, in the case of negative externalities such as pollution, the production costs of a firm may not include the environmental damage it causes, resulting in higher levels of output and pollution than is socially desirable. As a result, government intervention or market-based mechanisms such as taxes or subsidies may be needed to internalize the external costs or benefits and achieve a more efficient outcome.

When Externalities Exist, Buyers and Sellers