Suppose an oil refinery produces air pollution that negatively affects the surrounding residents. Which of the following is not a policy the government could take to correct this externality? -Subsidize the refinery’s product. -Require the refinery to pay for and install scrubbers so that no pollution is released. -Estimate the damages caused by the pollution and force the refinery to pay that amount. -Enact an excise tax on the refinery’s product.

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A:

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Market Failure Analysis

To understand Market failure, we need to first understand welfare economics. An Italian economist, Vilfredo Pareto stated that allocation of resources in an efficient manner such that an economic change, which harms no one and makes someone better off, indicates an increase in social welfare. It is also called Pareto Optimality, where resources cannot further be reallocated without harming one. This does not apply to those economic changes, which harm some and benefit others. social welfare increases if the utility of any of its members' increases and none decrease in the economy.