When analyzing externalities, how can changes in the prices of complements or substitutes for a product affect its social benefits and social costs?

• A. They can alter the demand for the product, which may change the magnitude of externalities and thus affect social benefits and social costs.
• B. They only affect the private costs of production, not the social costs or benefits.
• C. They always increase the social benefits regardless of the direction of the price change.
• D. They have no impact on the product's externalities or its social benefits and social costs.

Answer: (A)

Verified step by step guidance

1. Step 1: Understand the concept of externalities. Externalities occur when the production or consumption of a good affects third parties who are not directly involved in the market transaction, leading to social benefits or social costs that differ from private benefits or costs.
2. Step 2: Recognize that the demand for a product depends not only on its own price but also on the prices of related goods, such as complements (goods used together) and substitutes (goods used in place of each other).
3. Step 3: Analyze how a change in the price of a complement or substitute affects the demand for the original product. For example, if the price of a complement decreases, the demand for the original product may increase, and vice versa.
4. Step 4: Connect the change in demand to externalities. Since externalities depend on the quantity consumed or produced, a change in demand can alter the magnitude of external benefits or costs associated with the product.
5. Step 5: Conclude that changes in the prices of complements or substitutes can indirectly affect social benefits and social costs by shifting demand and thus changing the scale of externalities, rather than directly affecting private costs or always increasing social benefits.