In the context of externalities, how do power plants typically determine the amount of pollution they are allowed to emit?

• A. By choosing emission levels based solely on their profit-maximizing output
• B. By negotiating directly with affected local residents for acceptable pollution levels
• C. By following industry self-regulation without any government oversight
• D. By adhering to government-imposed regulations and permits that set emission limits

Answer: (D)

Verified step by step guidance

1. Understand that externalities occur when a firm's actions impose costs or benefits on third parties not involved in the market transaction. Pollution from power plants is a classic example of a negative externality.
2. Recognize that because pollution imposes social costs not reflected in the firm's private costs, unregulated firms tend to emit more pollution than is socially optimal if they only maximize profits.
3. Learn that governments intervene to correct this market failure by imposing regulations or issuing permits that limit the amount of pollution a firm can emit. These limits are designed to internalize the externality by making firms bear the social cost of pollution.
4. Note that power plants typically do not decide pollution levels solely based on profit maximization or direct negotiation with affected residents, nor do they rely only on self-regulation without oversight.
5. Therefore, the standard approach is that power plants determine their allowable pollution levels by adhering to government-imposed regulations and permits that set specific emission limits.