Which of the following activities is most likely to produce an externality?

• A. A company paying wages to its employees
• B. A student studying alone in their room
• C. A person buying groceries for personal consumption
• D. A factory releasing pollutants into a river

Answer: (D)

Verified step by step guidance

1. Step 1: Understand the concept of an externality. An externality occurs when a decision causes costs or benefits to third parties who are not directly involved in the activity. These effects can be either positive or negative and are not reflected in market prices.
2. Step 2: Analyze each activity to see if it affects third parties outside the transaction. For example, paying wages to employees is a private transaction between employer and employees, with no direct impact on outsiders.
3. Step 3: Consider the student studying alone and the person buying groceries. Both activities primarily affect only the individuals involved, with no significant spillover effects on others.
4. Step 4: Examine the factory releasing pollutants into a river. This activity imposes costs on others, such as downstream users or the environment, who are not part of the factory's decision-making process. This is a classic example of a negative externality.
5. Step 5: Conclude that the activity most likely to produce an externality is the factory releasing pollutants, because it creates unintended costs for third parties not involved in the production or consumption decisions.