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CA Foundation · Business Economics · Public Finance

Which of the following statements about the government's role in correcting market failure is correct?

Mandatory disclosure norms can improve outcomes under asymmetric information, as in securities markets, because they narrow the knowledge gap between parties. The other statements are wrong: positive externalities cause underproduction and call for subsidies, and public goods are underprovided by markets because of free riding.

  1. AUnder asymmetric information, mandatory disclosure norms can improve market outcomes, for example in the securities marketCorrect
  2. BA positive externality leads to overproduction, so the government should tax the activity
  3. CPublic goods are efficiently supplied by private markets because consumers willingly pay for them
  4. DPrice ceilings are the standard remedy for externalities in production

Explanation

Mandatory disclosure reduces the information gap between sellers and buyers or investors, which is a recognised remedy for asymmetric information. A positive externality leads to underproduction, so the remedy is a subsidy, not a tax. Public goods are underprovided by markets because of free riding. Price ceilings do not address externalities.

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