If an economic activity results in external costs as well as private costs, economic theory would suggest that this activity should:
A) be taxed.
B) be prohibited.
C) be subsidized.
D) not be allowed.

Question

Quizplus · Accepted Answer

When an economic activity generates both external costs and private costs, it means that the costs to society as a whole are greater than the costs to the individual or the firm carrying out the activity. To address this market failure, the activity should be taxed to reflect the social cost and make it less attractive for the individual/firm to engage in it. The tax revenue can then be used to compensate those who bear the external costs, or to promote alternative activities with lower costs. Prohibiting the activity may not be feasible or efficient, and subsidizing it would only exacerbate the problem by encouraging more of it. Not allowing the activity is not a practical option.

If an Economic Activity Results in External Costs as Well