Question

What is the role of government when external benefits or costs occur?

a. The government should not become involved in the market and should leave it up to market participants to settle any issues.

  

b. The government should provide subsidies to those with low income in the case of external costs.

c. The government should require producers who impose external costs to reduce their output and to increase their output in the case of external benefits.

d. The government should calculate the magnitude of the external costs (or benefits) and use subsidies and taxes to achieve the "right" rate of output in the affected industry.

Answer 1

Government plays in important role in analysing the external costs and benefits which occur in a society. We know that External costs are imposed when an action by one person or firm harms another, outside of any market exchange. In the case of external costs, private costs are less than social costs. Similarly, external benefits are created when an action by one person or firm benefits another, outside of any market exchange. External benefits are always good for the society. The external costs of a firm or industry are closely monitired till the required solution is found. An external benefit occurs when producing or consuming a good causes a benefit to a third party. The existence of external benefits (positive externalities) means that social benefit will be greater than private benefit.

The correct option is (d).

d. The government should calculate the magnitude of the external costs (or benefits) and use subsidies and taxes to achieve the "right" rate of output in the affected industry.

Pollution is an example of external cost and external benefit is the goods that a firm produces for the betterment of society.

Hope you got the answer.

Kindly comment for further explanation.

Thanks!