CA Foundation · Business Economics · Public Finance

A state government gives a subsidy to farmers who plant trees on their land, because the trees benefit the wider community by improving air quality. The main economic rationale for this subsidy is to:

The subsidy aims to correct under-provision caused by a positive externality. Farmers do not receive the community's benefit of cleaner air, so they plant too few trees. The subsidy raises their private return toward the social benefit, moving output closer to the socially optimal level.

AReduce the market price of timber to consumers
BCorrect under-provision caused by a positive externality by bringing private benefit closer to social benefitCorrect
CDiscourage the production of goods with negative externalities
DRaise tax revenue for the government

Explanation

Tree planting creates external benefits not captured by farmers, so the market supplies too little. A subsidy raises the farmers' private return toward the social benefit, increasing the quantity toward the optimum. Discouraging negative externalities is the aim of a tax, not a subsidy, and the subsidy lowers rather than raises revenue.

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