In a market with external costs, suppose the efficient level of output is 1,000 units. Which of the following statements is TRUE?
A) To achieve the efficient level of output, the government should set a subsidy equal to the external cost.
B) To achieve the efficient level of output the government could set a tax equal to the external cost or issue enough tradeable allowances to restrict the output to the efficient level.
C) With external costs, the government can use only taxes to achieve the efficient level of output.
D) With external costs, the government can use only tradeable allowances to achieve the efficient level of output.

Question

Quizplus · Accepted Answer

To achieve the efficient level of output in a market with external costs, the government could either set a tax equal to the external cost or issue enough tradable allowances to restrict the output to the efficient level. This is because both methods create a cost for producers that takes into account the external costs imposed on society. By setting the tax or issuing tradable allowances, the government internalizes the external costs, leading to the efficient level of output being produced. Option A is incorrect, as a subsidy would encourage the production of more goods and result in an overproduction of the good, leading to an inefficient outcome. Option C is incorrect, as the government has both a tax and trading policy available to achieve the efficient level of output. Similarly, option D is incorrect, since only allowing tradeable allowances would limit the government's ability to achieve the efficient output level.

In a Market with External Costs, Suppose the Efficient Level