Which of the following restrictive practices is most closely related to the presence of externalities in terms of social benefits and social costs?

• A. Imposing taxes or subsidies to internalize externalities
• B. Implementing quotas to restrict market entry
• C. Enforcing minimum wage laws
• D. Setting price floors in competitive markets

Answer: (A)

Verified step by step guidance

1. Step 1: Understand the concept of externalities. Externalities occur when a market activity causes costs or benefits to third parties that are not reflected in market prices. These can be either positive (benefits) or negative (costs).
2. Step 2: Recognize that externalities lead to a divergence between private costs/benefits and social costs/benefits. This means the market equilibrium is not socially optimal because some costs or benefits are not accounted for by the market participants.
3. Step 3: Identify the policy tools used to address externalities. The main approach is to 'internalize' the externality, which means adjusting incentives so that private decision-makers take into account the external costs or benefits. This is often done through taxes (to reduce negative externalities) or subsidies (to encourage positive externalities).
4. Step 4: Compare the given options to the concept of internalizing externalities. Imposing taxes or subsidies directly targets the external costs or benefits, aligning private incentives with social welfare.
5. Step 5: Conclude that other options like implementing quotas, enforcing minimum wage laws, or setting price floors do not primarily focus on correcting externalities but rather on other market issues such as market entry, labor standards, or price controls.