In the context of public solutions to externalities, what is the government's primary aim in setting quotas?

• A. To encourage unlimited production and consumption
• B. To maximize producer profits by restricting competition
• C. To eliminate all market transactions for the good
• D. To limit the quantity of a good or activity to reduce negative externalities

Answer: (D)

Verified step by step guidance

1. Understand that externalities occur when a market activity affects third parties not directly involved in the transaction, often leading to inefficient market outcomes.
2. Recognize that negative externalities, such as pollution, cause social costs that exceed private costs, resulting in overproduction or overconsumption of the good.
3. Know that the government can intervene by setting quotas, which are limits on the quantity of a good or activity allowed in the market.
4. The primary aim of setting quotas is to reduce the quantity produced or consumed to a socially optimal level, thereby reducing the negative externalities associated with the good.
5. Thus, quotas serve as a regulatory tool to restrict the quantity, not to encourage unlimited production, maximize profits, or eliminate all transactions, but to correct the market failure caused by negative externalities.