Final answer:
Flu shots generate a deadweight loss in a free market because they are associated with positive externalities that the market does not fully account for, leading to underconsumption. Hence correct answer is a) They are overproduced in a free market.
Step-by-step explanation:
The question at hand revolves around why flu shots and other goods that produce external benefits cause a deadweight loss in a free market. The notion of external benefits, or positive externalities, refers to the additional advantages that third parties receive as a result of a transaction to which they were not a direct party. In the case of flu shots, the external benefit is the reduced chance that others will contract the flu when an individual is vaccinated.
In a free market, the quantity of flu shots produced and consumed is at QMarket, where the marginal private benefit (MPB) is equal to the marginal private cost (MPC). However, this does not take into account the marginal social benefit (MSB) which includes the spillover benefits. The MSB is greater than the MPB, which indicates that the market equilibrium quantity (QMarket) is less than the socially optimal quantity (QSocial) that would be preferred if these external benefits were recognized by the market.
To correct this market failure, where the positive externality leads to underconsumption, a subsidy can be provided. This subsidy should equal the difference between the marginal social benefit and the marginal private benefit. Through such government intervention, the consumption can be increased to QSocial, which is the socially optimal level of flu shots.
The correct option in the final answer regarding why flu shots and other goods with external benefits generate a deadweight loss is because they are under-consumed due to the market not recognizing the full benefits they provide, which is closest to option c) They create market inefficiencies.