Externalities can occur in either a competitive or noncompetitive market. The best efficiency...


Externalities can occur in either a competitive or noncompetitive market.

The best efficiency solution would be to break up the noncompetitive market structure to create a competitive market, and then impose a corrective tax to reach efficiency.

1. Explain why this may not always be possible.

2. What would be the solution under this situation? Explain why this would be "best".


Externalities are unintentional negative or positive effects on third parties. One example is pollution, a negative externality on the environment and society that is not considered by the transacting parties. Another example is a fireworks show. Spectators benefit from the show without paying for it.

Externalities aren't automatically considered in the pricing of goods or services that have them as unintended effects. Because of this, goods and services with externalities are not priced right. Products with negative externalities are underpriced and overproduced, while products with positive externalities are overpriced and underproduced. To correct externalities, governments may measure the negative or positive impact of the externalities and impose a corrective tax or subsidy to bring prices to their equilibrium level had the externalities been considered.

Answer and Explanation:

While breaking up a non-competitive market is ideal, it isn't always possible. In the case of industries with very high barriers to entry, it makes sense for governments to allow monopolies. These are called natural monopolies and are usually heavily regulated by governments. Like other monopolies, a natural monopoly may abuse its market position. Since breaking up natural monopolies will be less efficient and sometimes impossible, governments choose to regulate these industries to safeguard the welfare of consumers. Sometimes, governments choose to run the industry themselves. Regulating industries is not straightforward and requires some ingenuity.

Learn more about this topic:

Natural Monopoly in Economics: Definition & Examples

from Intro to Business: Help and Review

Chapter 3 / Lesson 13

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