Skip to content

IAI Actuarial Core Principles · Business Economics · Government intervention in a market

A cement plant in a river valley discharges dust that damages nearby farms. The plant's own costs do not include this damage. Which description best explains why the market output of cement is likely to be socially excessive?

The market output is excessive because the plant ignores a negative externality: marginal social cost exceeds marginal private cost, so the firm produces beyond the socially optimal quantity where social cost equals social benefit, and the farmers bear the uncompensated damage.

  1. AMarginal social cost exceeds marginal private cost, so the market ignores a negative externalityCorrect
  2. BMarginal social benefit exceeds marginal private benefit, so the market ignores a positive externality
  3. CThe plant has a monopoly and restricts output below the competitive level
  4. DConsumers lack information about the quality of cement
  5. Cement is a public good that is non-excludable

Explanation

Dust damage is a cost borne by third parties. Because the firm ignores it, marginal private cost is below marginal social cost, and the market produces where private cost equals benefit, which is more than the social optimum. Option 1 describes positive externalities, which lead to under-provision.

Did you get it right without looking?

One question tells you little. A timed set on Government intervention in a market shows your real accuracy, how long you take and where you lose marks.

Practise Government intervention in a marketFree diagnostic mock

More Government intervention in a market questions