Which of the following is a way governments get involved in markets to address externalities?

• A. Imposing taxes or subsidies
• B. Ignoring the presence of externalities
• C. Setting prices based solely on consumer preferences
• D. Allowing markets to operate without any intervention

Answer: (A)

Verified step by step guidance

1. Understand what an externality is: an externality occurs when a market transaction affects third parties who are not directly involved, leading to either positive or negative side effects.
2. Recognize that governments intervene in markets to correct these externalities because free markets alone may not allocate resources efficiently when external costs or benefits exist.
3. Identify common government interventions: these include imposing taxes on activities that generate negative externalities (to reduce their occurrence) or providing subsidies for activities that generate positive externalities (to encourage them).
4. Evaluate the options given: ignoring externalities or setting prices solely based on consumer preferences do not address the external costs or benefits, and allowing markets to operate without intervention means no correction is made.
5. Conclude that the correct way governments get involved to address externalities is by imposing taxes or subsidies, as this internalizes the external costs or benefits into market prices.