Which of the following is an example of a public solution to externalities?

• A. Allowing firms to merge and form monopolies
• B. Imposing a tax on firms that generate pollution
• C. Relying solely on private bargaining between affected parties
• D. Increasing subsidies for all industries regardless of their externalities

Answer: (B)

Verified step by step guidance

1. Step 1: Understand what externalities are — these are costs or benefits that affect third parties who are not directly involved in an economic transaction.
2. Step 2: Recognize that a public solution to externalities typically involves government intervention to correct market failures, such as taxes, subsidies, or regulations.
3. Step 3: Evaluate each option to see if it represents government action aimed at internalizing the externality. For example, imposing a tax on firms that generate pollution is a classic public solution called a Pigouvian tax.
4. Step 4: Identify that allowing firms to merge and form monopolies is not a public solution to externalities; it may create other market issues like reduced competition.
5. Step 5: Note that relying solely on private bargaining or increasing subsidies indiscriminately are not targeted public solutions to externalities, as they either depend on private negotiation or do not address the externality specifically.