Which intervention explicitly moves the economy toward the social optimum by increasing consumption of the good with a positive externality?

Which intervention explicitly moves the economy toward the social optimum by increasing consumption of the good with a positive externality?

• A. A per-unit tax on the good
• B. A price ceiling on the good
• C. A per-unit subsidy to consumers
• D. A government ban on the good

Answer: (C)

When a good has a positive externality, the social benefit from consuming it exceeds what individual consumers take into account. The private demand curve underestimates the true social value, so the market tends to underconsume. A per-unit subsidy to consumers directly changes the incentive: it lowers the price consumers pay, effectively boosting their willingness to buy by the subsidy amount. This shifts the private demand outward, increasing the quantity consumed toward the level that includes the external benefits. In other words, the subsidy aligns private decisions with the higher social payoff, internalizing the external benefit and moving the economy toward the social optimum. Other interventions would not achieve this effect. A per-unit tax discourages consumption and would widen the gap between private and social benefits. A price ceiling can create shortages and misallocation without ensuring higher social welfare. A government ban eliminates the good entirely, removing the potential positive externalities.

When a good has a positive externality, the social benefit from consuming it exceeds what individual consumers take into account. The private demand curve underestimates the true social value, so the market tends to underconsume. A per-unit subsidy to consumers directly changes the incentive: it lowers the price consumers pay, effectively boosting their willingness to buy by the subsidy amount. This shifts the private demand outward, increasing the quantity consumed toward the level that includes the external benefits. In other words, the subsidy aligns private decisions with the higher social payoff, internalizing the external benefit and moving the economy toward the social optimum.

Other interventions would not achieve this effect. A per-unit tax discourages consumption and would widen the gap between private and social benefits. A price ceiling can create shortages and misallocation without ensuring higher social welfare. A government ban eliminates the good entirely, removing the potential positive externalities.