Multiple-Choice Questions on Externalities

What is an externality in economics?

• A cost or benefit that affects only the buyer and seller in a transaction

• A cost or benefit that affects a third party not directly involved in the transaction

• A tax imposed by the government to reduce pollution

• A price floor that distorts market efficiency

Which of the following is an example of a negative externality?

• A person receiving a flu vaccine

• A beekeeper’s bees pollinating nearby crops

• A factory emitting pollution into a river

• A company providing employee training that benefits future employers

Which of the following is an example of a positive externality?

• Traffic congestion due to increased car usage

• Loud music from a neighbor disturbing others

• A student receiving education that benefits society

• A company dumping waste into a lake

If negative externalities are present in a market, what will be the outcome?

• The market will produce too much of the good at too high a price

• The market will produce too little of the good at too high a price

• The market will produce too much of the good at too low a price

• The market will produce an efficient quantity of the good

When externalities are present, what problem arises in free markets?

• Prices will always be too high

• Market failure occurs because private costs or benefits differ from social costs or benefits

• The government must subsidize all goods and services

• Consumer surplus is eliminated

What is the economic term for the sum of private costs and external costs?

• Marginal social cost

• Marginal private cost

• Marginal external benefit

• Marginal consumer benefit

What happens when a government imposes a corrective (Pigouvian) tax on a good that generates a negative externality?

• The quantity produced increases

• The price falls

• The quantity produced decreases

• The market price remains unchanged

Which of the following is a government policy that directly addresses negative externalities?

• Eliminating taxes on businesses

• Subsidizing goods with external costs

• Imposing tradable pollution permits

• Allowing firms to ignore externalities

The Coase theorem suggests that externalities can be efficiently resolved if:

• The government strictly regulates externalities

• The number of parties involved is small, and transaction costs are low

• Firms are allowed to produce without restrictions

• The government provides a subsidy for external costs

A Pigouvian subsidy is designed to:

• Encourage production of goods that generate negative externalities

• Discourage production of goods with positive externalities

• Encourage production of goods with positive externalities

• Eliminate government intervention in markets