Discussion
The production of a good results in positive externalities. The government should:
Answer: A
When production gives a positive externality, the social benefit exceeds the private benefit and the market produces too little. The government should give the producer a subsidy equal to the marginal external benefit, so as to raise output to the social optimum. A tax would reduce output further, and the cost of an externality is not what a subsidy reflects. The key gives option A. The subsidy raises the output of the producer to the level where the marginal social benefit equals the marginal social cost.
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