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IAI Actuarial Core Principles · Business Economics · Relationship between the government and the individual firm

Which of the following is the best example of a positive externality that could justify a government subsidy?

Worker training that benefits other employers is a positive externality because the social benefit exceeds the private benefit to the training firm. The market under-provides it, which can justify a subsidy. The other options are negative externalities or other issues.

  1. AA steel mill discharging effluent into a river
  2. BA firm training workers whose skills are later used by other employersCorrect
  3. CA smoker lighting a cigarette in a restaurant
  4. DA monopolist restricting output to raise price
  5. An insurer charging higher premiums to high-risk customers

Explanation

Training gives benefits to other firms that the trainer cannot capture, so social benefit exceeds private benefit and training is under-provided. The other options are negative externalities, monopoly power or risk pricing.

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