When an external cost exists in the production of a good, firms tend to
A) under-produce the good since society pays these costs.
B) over-produce the good.
C) keep production constant throughout the year.
D) under-allocate resources to the production of the good.

Question

Quizplus · Accepted Answer

When external costs exist, such as pollution or traffic congestion, they are not borne by the producer but by society as a whole. This means that firms do not take these costs into account when making production decisions, and therefore tend to over-produce the good. This is because the private cost of production is lower than the social cost, and firms only care about maximizing their profits based on their private costs. As a result, external costs can lead to market inefficiencies and overproduction of goods.

When an External Cost Exists in the Production of a Good