Question

In the presence of a negative externality, how would the benevolent social planner act?

a) The social planner would do nothing and let the market self-regulate.
b) The social planner would impose taxes on the activity causing the externality.
c) The social planner would provide subsidies to the activity causing the externality.
d) The social planner would ban the activity causing the externality.

Answer 1

A benevolent social planner would likely impose taxes on the activity causing a negative externality to correct the market failure and align private costs with social costs.

Step-by-step explanation:

In the presence of a negative externality, such as pollution, a benevolent social planner would take action because externalities represent a case where the market fails to consider all social costs. Since a negative externality means that private market transactions impose a cost on uninvolved third parties that is not reflected in market prices, leading to overproduction of the product causing the harm, the social planner would intervene to correct this market failure. Typically, the social planner would opt for option (b), imposing taxes on the activity causing the externality, which helps to internalize the external costs and align private costs with social costs, ultimately leading to a reduction in the harmful activity.