The following text is about economics.
Externalities are costs or benefits that affect parties not directly involved in a transaction. A factory polluting a river imposes costs on downstream fishers without compensating them—a negative externality. Research that benefits society beyond the researcher represents a positive externality. Because producers don't bear full costs of negative externalities or capture full benefits of positive ones, markets may overproduce harmful goods and underproduce beneficial ones. Economists propose corrections through taxes (on negative externalities), subsidies (for positive ones), or property rights that force internalization of costs.
According to the text, why do externalities cause market inefficiency?
Markets always correctly price all effects
Producers don't bear all costs or capture all benefits, distorting production decisions
Government intervention always makes markets worse
Externalities only affect the producers themselves
Correct Answer: B
Choice B is the correct answer. The text states "producers don't bear full costs of negative externalities or capture full benefits of positive ones," causing over- or under-production.
- Evidence: Incomplete cost/benefit allocation distorts production.
- Reasoning: Without full accounting, producers make inefficient choices.
- Conclusion: Misaligned incentives cause market failure.
Choice A is incorrect because markets fail to account for externalities. Choice C is incorrect because taxes/subsidies are proposed as solutions. Choice D is incorrect because externalities by definition affect third parties.