Consider two goods-one that generates external benefits and another that generates external costs. A competitive market economy would tend to produce:
A)too much of both goods, relative to the social optimum.
B)too little of both goods, relative to the social optimum.
C)too much of the good that generates external benefits relative to the social optimum, and too little of the good that generates external costs.
D)too little of the good that generates external benefits relative to the social optimum, and too much of the good that generates external costs.

Question

Consider two goods-one that generates external benefits and another that generates external costs. A competitive market economy would tend to produce:
A)​too much of both goods, relative to the social optimum.
B)​too little of both goods, relative to the social optimum.
C)​too much of the good that generates external benefits relative to the social optimum, and too little of the good that generates external costs.
D)​too little of the good that generates external benefits relative to the social optimum, and too much of the good that generates external costs.

Quizplus · Accepted Answer

In a competitive market economy, firms only consider private costs and benefits while making production or consumption decisions. Therefore, they will produce too little of the good that generates external benefits because they do not receive the full benefit of their actions, and too much of the good that generates external costs because they are not paying for the full cost of their actions. Thus, the outcome will be suboptimal from the perspective of society as a whole, resulting in a deadweight loss.

Consider Two Goods-One That Generates External Benefits and Another That