Which of the following mitigation tactics could reduce the economic risk associated with negative externalities?

• A. Increasing barriers to entry for firms in the market
• B. Ignoring the external costs and allowing the market to operate freely
• C. Imposing a tax equal to the external cost
• D. Subsidizing the production of goods with negative externalities

Answer: (C)

Verified step by step guidance

1. Step 1: Understand what a negative externality is — it occurs when the production or consumption of a good imposes costs on third parties that are not reflected in the market price.
2. Step 2: Recognize that economic risk from negative externalities arises because the market outcome leads to overproduction or overconsumption of the harmful good, causing social costs.
3. Step 3: Evaluate each mitigation tactic by considering whether it internalizes the external cost, meaning it makes producers or consumers bear the full social cost of their actions.
4. Step 4: Analyze why imposing a tax equal to the external cost (a Pigouvian tax) aligns private costs with social costs, thereby reducing overproduction and mitigating the negative externality.
5. Step 5: Contrast this with other options: increasing barriers to entry may reduce competition but does not directly address external costs; ignoring external costs leaves the problem uncorrected; subsidizing production encourages more of the harmful good, worsening the externality.