1. An externality arises when a person engages in an activity that influences the well-being of...

1. An externality arises when a person engages in an activity that influences the well-being of
A. buyers in the market for that activity and yet neither pays nor receives any compensation for that effect.
B. sellers in the market for that activity and yet neither pays nor receives any compensation for that effect.
C. the government and requires the government to either pay or receive compensation for that effect.
D. bystanders in the market for that activity and yet neither pays nor receives any compensation for that
effect.
E. Both A and B

2. Which of the following statement(s) is correct?
(x) An externality is the uncompensated impact of one person's actions on the well-being of a bystander.
(y) An externality exists whenever markets are not able to reach equilibrium.
(z) In a market economy, government intervention may improve market outcomes in the presence of
externalities.
A. (x), (y) and (z)
B. (x) and (y) only
C. (x) and (z) only
D. (y) and (z) only
E. (z) only

The existence of an externality
(x) results in a market equilibrium that does not maximize the total benefits to society.
(y) affects buyers but not sellers and causes demand to exceed supply.
(z) strengthens the role of the “invisible hand” in the marketplace.
A. (x), (y) and (z)
B. (x) and (y) only
C. (x) and (z) only
D. (y) and (z) only
E. (x) only

Solutions

Expert Solution

Q1. An externality is defined as an activity by an individual that affects a third party even though they don't pay for it. So the correct option is D) externality affects a bystander and neither pays nor receives a compensation for that.

Q2. for this question, (x) is correct as explained in the question above. y) is incorrect because there are other reasons as well for market not reaching an equilibrium, externality is not the only reason. z) is correct, because government may tax the externaity in a way that outcome may improve. Therefore correct option is C)

Q3. Because of the externality, the market does not maximize the benefit to the society by definition. So x is correct. It is the only correct statement. Therefore the correct option is E)

Rahul Sunny answered 2 years ago

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