Refer to the diagram in which S is the market supply curve and S₁ is a supply curve comprising all costs of production,including external costs.Assume that the number of people affected by these external costs is large.If the government wishes to establish an optimal allocation of resources in this market,it should:

Question

Quizplus · Accepted Answer

Since the supply curve comprising all costs of production, including external costs, does not reflect the true cost of production, the government should intervene to internalize the external costs. A tax on producers would increase their costs and shift the market supply curve upward, leading to a higher equilibrium price and a lower equilibrium quantity. This would incentivize producers to reduce their output and internalize the external costs, resulting in a more socially optimal allocation of resources. Subsidizing consumers or producers would not address the issue of external costs and could even exacerbate the problem by increasing consumption and production. Not intervening is not a viable option because the market outcome is not optimal due to the presence of external costs.

Refer to the Diagram in Which S Is the Market