Which of the following is a public solution to negative externalities in microeconomics?

• A. Increasing subsidies for the production of the good causing the externality
• B. Encouraging voluntary agreements between affected parties
• C. Allowing the market to self-regulate without intervention
• D. Imposing a Pigovian tax on the activity causing the externality

Answer: (D)

Verified step by step guidance

1. Understand what a negative externality is: it occurs when the production or consumption of a good causes a cost to a third party that is not reflected in the market price.
2. Recognize that public solutions aim to correct market failures caused by negative externalities by aligning private costs with social costs.
3. Evaluate each option: increasing subsidies would encourage more production, potentially worsening the externality; voluntary agreements are private solutions, not public interventions; allowing the market to self-regulate assumes no intervention, which often fails to address externalities effectively.
4. Identify that a Pigovian tax is a government-imposed tax equal to the external cost per unit of the good, which internalizes the externality by making producers pay for the social cost.
5. Conclude that imposing a Pigovian tax is a classic public policy tool designed to reduce negative externalities by increasing the private cost to reflect the true social cost.