When there is market failure due to a negative externality:
A) there are no ways of correcting it.
B) setting the price of the good equals to its marginal social cost will solve it.
C) the free market produces output at a too high price.
D) externalities have been taken into account.

Question

Quizplus · Accepted Answer

When there is market failure due to a negative externality, the free market produces output at a too low price, since it does not take into account the cost to society of this externality. Setting the price of the good equal to its marginal social cost (by either taxing the producer or subsidizing the consumer) will lead to a socially efficient outcome where the cost of the externality is accounted for. Therefore, option B is the best choice. Options A, C, and D are incorrect as there are ways to correct negative externalities, the free market produces output at a too low (not high) price, and externalities have not been taken into account in this scenario.

When There Is Market Failure Due to a Negative Externality