Which of the following statements is not correct? (a) The market mechanism over-produces a good that generates positive externality. (b) A cap and trade of pollution permits can be used by the government to achieve the social optimum. (c) The optimal amount of subsidy in the case of an activity that produces a positive externality is the difference between the social benefit and the private benefit at the optimum. (d) Tragedy of Commons is an example of negative externality.

The market mechanism fails to achieve efficiency when externalities are present. In the case of positive externalities, the private market results in underproduction because individuals or firms do not account for the external benefits provided to others [1]. Consequently, the marginal social benefit exceeds the marginal private benefit, leading to a quantity lower than the social optimum. Conversely, negative externalities lead to overproduction [1]. Statement (b) is correct as cap-and-trade systems create economic incentives to reach social optimums. Statement (c) is correct because the optimal subsidy should equal the marginal external benefit, which is the difference between social and private benefits at the optimum [1]. Statement (d) is correct as the Tragedy of the Commons involves individuals overusing a shared resource, imposing negative externalities on others [1]. Therefore, statement (a) is the incorrect one.

Sources

1. [1] https://www.imf.org/en/publications/fandd/issues/series/back-to-basics/externalities