A positive externality exists and government wants to apply a per-unit subsidy in order to bring about an efficient outcome.Under what condition will the solution (the subsidy)be worse than the problem (the market failure)?

Question

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The per-unit subsidy may lead to a situation where the post-subsidy output is farther away from the efficient level of output than the pre-subsidy output is from the efficient level of output. This can happen if the subsidy is too large and encourages overproduction beyond the efficient level. In such a case, the solution (subsidy) can be worse than the problem (market failure). Option A and D are incorrect because if the subsidy is less than or equal to the marginal external benefit, it will help achieve an efficient outcome. Option B is incorrect because if the post-subsidy output is closer to the efficient level of output than the pre-subsidy output, it will result in an improvement.

A Positive Externality Exists and Government Wants to Apply a Per-Unit