Question

When producers operate in a market characterized by negative externalities, a tax that forces them to internalize the externality will:

a. give sellers the incentive to account for the external effects of their actions.
b. increase demand.
c. increase the amount of the commodity exchanged in market equilibrium.
d. restrict the producers' ability to take the costs of the externality into account when deciding how much to supply.

Answer 1

A) give sellers the incentive to account for the external effects of their actions.

Step-by-step explanation:

The effect of levying a tax that represents the cost of the externality could lead to one of two outcomes:

• Firms that are causing the externality add the cost of the externality in the final price of their products.
• Firms that are causing the externality attempt to reduce or eliminate the externality, so that prices remain the same, and competitiveness is not lost.

For example, the most common example of an externality is pollution, therefore, the industrial sector operates in a market characterized by negative externalities. If the government levied a tax on factories accounting for the pollution they produce, these factores either would increase prices, or try to reduce pollution.