Questions: Refer to the diagram in which S is the market supply curve and S1 is a supply curve comprising all costs of production, including external costs. Assume that the number of people affected by these external costs is large. If the government wishes to establish an optimal allocation of resources in this market, it should: - subsidize consumers so that the market demand curve shifts leftward. - not intervene because the market outcome is optimal. - subsidize producers so that the market supply curve shifts leftward (upward). - tax producers so that the market supply curve shifts leftward (upward).

Refer to the diagram in which S is the market supply curve and S1 is a supply curve comprising all costs of production, including external costs. Assume that the number of people affected by these external costs is large. If the government wishes to establish an optimal allocation of resources in this market, it should:
- subsidize consumers so that the market demand curve shifts leftward.
- not intervene because the market outcome is optimal.
- subsidize producers so that the market supply curve shifts leftward (upward).
- tax producers so that the market supply curve shifts leftward (upward).

Transcript text: Refer to the diagram in which $S$ is the market supply curve and $S_{1}$ is a supply curve comprising all costs of production, including external costs. Assume that the number of people affected by these external costs is large. If the government wishes to establish an optimal allocation of resources in this market, it should: subsidize consumers so that the market demand curve shifts leftward. not intervene because the market outcome is optimal. subsidize producers so that the market supply curve shifts leftward (upward). tax producers so that the market supply curve shifts leftward (upward).

Solution

Solution Steps

Step 1: Understand the Diagram and Problem

The diagram shows two supply curves: $ S $ (market supply curve) and $ S_1 $ (supply curve including external costs). The demand curve is $ D $. The problem asks what the government should do to achieve an optimal allocation of resources, considering the external costs.

Step 2: Identify the External Costs

The supply curve $ S_1 $ includes external costs, which means it represents the true cost of production, including negative externalities. The market supply curve $ S $ does not include these external costs, leading to overproduction and a lower price than socially optimal.

Step 3: Determine the Government Intervention

To correct the market failure caused by the external costs, the government should aim to shift the market supply curve $ S $ to $ S_1 $. This can be achieved by internalizing the external costs through taxation.