Economics · Public Finance and Externalities
In an economy with externalities, which statement regarding Pareto efficiency is CORRECT?
Verified Solution4 OptionsUpdated: October 2026👁️1 View
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- 1The Pareto optimal output level in the presence of a negative production externality is always greater than the competitive market output.
- 2Positive consumption externalities lead to overproduction in a competitive equilibrium.
- 3Negative production externalities cause competitive markets to overproduce relative to the Pareto optimal level; a Pigouvian tax corrects this by equating private and social marginal costs.✓
- 4Competitive markets always achieve Pareto efficiency regardless of external effects.
Correct answer
Negative production externalities cause competitive markets to overproduce relative to the Pareto optimal level; a Pigouvian tax corrects this by equating private and social marginal costs.
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