To ensure an efficient equilibrium outcome when external costs are present in the market, the government could:
I. implement a tax equal to the level of the external cost.
II. create a system of tradable allowances to reduce output to the efficient quantity.
III. institute command and control policies to reduce output to the efficient quantity.
A) I and II only
B) II and III only
C) II only
D) I, II, and III

Question

Quizplus · Accepted Answer

Option I involves a Pigouvian tax, which would make the private costs match the social costs, reducing the overproduction of the goods with externalities. Option II is about establishing a cap and trade system that would limit the amount of pollution that each company can produce. This option motivates companies to reduce their production levels, cutting the amount of externality produced. Option III, command and control policies, can help reduce the externality, but sometimes they can be expensive or inefficient. Therefore, options I and II are better choices than III.

To Ensure an Efficient Equilibrium Outcome When External Costs Are