Which of the following statements best describes federal grants-in-aid in the context of public solutions to externalities?

• A. They are direct payments from the federal government to private firms to subsidize production.
• B. They are taxes imposed by the federal government to discourage negative externalities.
• C. They are funds provided by the federal government to state or local governments to support programs that address externalities.
• D. They are regulations set by the federal government that mandate specific production processes.

Answer: (C)

Verified step by step guidance

1. Step 1: Understand the concept of externalities, which are costs or benefits that affect third parties not directly involved in an economic transaction.
2. Step 2: Recognize that public solutions to externalities often involve government intervention to correct market failures, such as taxes, subsidies, regulations, or grants.
3. Step 3: Define federal grants-in-aid as funds provided by the federal government to state or local governments to support specific programs or projects, often aimed at addressing public issues like externalities.
4. Step 4: Differentiate grants-in-aid from other government tools: they are not direct payments to private firms (which would be subsidies), nor are they taxes or regulations.
5. Step 5: Conclude that federal grants-in-aid are best described as funds given to lower levels of government to help finance programs that mitigate externalities, aligning with the correct statement.