Consider a good that generates external benefits and another that generates external costs. A competitive market economy would tend to produce:
A)too much of both the goods relative to the social optimum of each good.
B)too little of both the goods relative to the social optimum of each good.
C)too much of the good that generates external benefits and too little of the good that generates external costs relative to the social optimum of each good.
D)too little of the good that generates external benefits and too much of the good that generates external costs relative to the social optimum of each good.
E)the same amount of both the goods as the social optimum of each good.

Question

Quizplus · Accepted Answer

When a good generates external benefits, the social marginal benefit exceeds the private marginal benefit. Since individuals only consider their private benefits when making consumption decisions, they will consume less than the socially optimal level of the good. On the other hand, when a good generates external costs, the social marginal cost exceeds the private marginal cost. Firms producing the good will only consider their private costs, which will lead them to produce more of the good than what is socially optimal. Thus, a competitive market economy would tend to produce too little of the good that generates external benefits and too much of the good that generates external costs relative to the social optimum of each good.

Consider a Good That Generates External Benefits and Another That