If there are external benefits associated with the consumption of a good or service, which of the following is most likely to occur in a free market without government intervention?

• A. There will be no impact on consumption compared to the socially optimal level.
• B. The good will be over-consumed relative to the socially optimal level.
• C. The good will be under-consumed relative to the socially optimal level.
• D. The good will be consumed at the socially optimal level.

Answer: (C)

Verified step by step guidance

1. Step 1: Understand the concept of external benefits (positive externalities). These occur when the consumption of a good or service provides benefits to third parties not directly involved in the transaction.
2. Step 2: Recognize that in a free market without government intervention, consumers base their decisions on private benefits and costs, ignoring the external benefits to others.
3. Step 3: Define the private marginal benefit (PMB) as the benefit to the consumer, and the social marginal benefit (SMB) as the total benefit to society, which includes both private and external benefits. Mathematically, this is: \(\text{SMB} = \text{PMB} + \text{External Benefit}\).
4. Step 4: Since consumers only consider PMB, the quantity demanded in the free market corresponds to where the private marginal benefit equals the marginal cost (PMC), not where the social marginal benefit equals the marginal cost (SMC). This leads to a lower quantity consumed than the socially optimal level.
5. Step 5: Conclude that because the social marginal benefit is higher than the private marginal benefit, the good will be under-consumed relative to the socially optimal level in a free market without intervention.