AP Microeconomics Practice Quiz: Externalities
Written by AP Content Team, Verified for 2026 AP Exams, Last updated: May 2026
Test your understanding with short quizzes. This quiz has 16 questions to check your progress.
Question 1 of 16
All Questions (16)
A) A cost or benefit that arises from a transaction and is fully accounted for in the market price.
B) A cost or benefit arising from an activity that affects a third party not directly involved in that activity.
C) The total economic surplus generated in a perfectly competitive market.
D) A government policy, such as a tax or subsidy, designed to influence market outcomes.
Correct Answer: B
Based on the provided content, externalities are costs or benefits that impact parties who are not part of the private transaction. Private markets fail to account for these external effects.
A) The market produces less than the socially optimal quantity because social benefits are ignored.
B) The market produces more than the socially optimal quantity because social costs are not considered by private agents.
C) The market produces the socially optimal quantity because rational agents will eventually account for all costs.
D) The market output is indeterminate without knowing the specific tax policy in place.
Correct Answer: B
With a negative externality, the marginal social cost is higher than the marginal private cost. Since private agents only respond to private costs, they will produce a quantity where marginal private benefit equals marginal private cost, which is greater than the socially optimal quantity where marginal social benefit equals marginal social cost.
A) over-regulation by government agencies.
B) lack of well-defined property rights.
C) tendency for markets to create monopolies.
D) inability of consumers to act rationally.
Correct Answer: B
The content explicitly states that externalities 'arise from lack of well-defined property rights and/or high transaction costs.' This lack of ownership prevents markets from pricing the external cost or benefit.
A) The marginal private benefit equals the marginal private cost.
B) Total revenue for producers is maximized.
C) The marginal social benefit equals the marginal social cost.
D) The number of consumers equals the number of producers.
Correct Answer: C
The content specifies that 'The socially optimal quantity of a good occurs where the marginal social benefit of consuming the last unit equals the marginal social cost of producing that last unit, thus maximizing total economic surplus.'
A) a negative externality in production.
B) a positive externality in consumption or production.
C) the free-rider problem associated with public goods.
D) high transaction costs in private markets.
Correct Answer: B
The content lists 'taxes/subsidies' as a policy to address externalities. Subsidies are used to encourage more of an activity. Since positive externalities result in the market producing less than the socially optimal quantity, a subsidy can increase production/consumption to the desired level.
A) rational agents overvalue the good, leading to overproduction.
B) the marginal social cost of production exceeds the marginal private cost.
C) producers are forced to bear external costs they did not create.
D) private agents do not consider the external benefits that accrue to society.
Correct Answer: D
The content states that 'in the presence of externalities, private markets do not take into consideration social costs or social benefits' and that 'rational agents respond to private costs and benefits and not to external costs and benefits.' For a positive externality, the unconsidered social benefits lead to underproduction.
A) Environmental regulation
B) Public provision
C) Price floors and ceilings
D) Assignment of property rights
Correct Answer: C
The provided content lists the following policies: 'taxes/subsidies, environmental regulation, public provision, the assignment of property rights, and the reassignment of property rights through private transactions.' Price floors and ceilings are not mentioned as a direct policy to address externalities.
A) High private costs
B) Well-defined property rights
C) A good being non-excludable
D) The presence of a negative externality
Correct Answer: C
The content directly links these concepts: 'Rational agents have the incentive to free ride when a good is non-excludable.' This means if a person cannot be prevented from using a good, they have an incentive to not pay for it.
A) increases the marginal social benefit to match the marginal private benefit.
B) forces producers to internalize the external cost, making the marginal private cost equal to the marginal social cost.
C) eliminates transaction costs, allowing for private reassignment of property rights.
D) transforms the good into a publicly provided good to eliminate the free-rider problem.
Correct Answer: B
A corrective tax on a negative externality increases the private cost of production. The goal of the tax is to make the producer's marginal private cost (including the tax) equal to the marginal social cost, thus forcing the 'rational agent' to respond to the full social cost of their actions and produce at the socially optimal level.
A) the government collects too much tax revenue.
B) the market produces a quantity where the marginal social cost exceeds the marginal social benefit.
C) potentially beneficial units of the good, where marginal social benefit exceeds marginal social cost, are not produced.
D) rational agents free ride, causing production to halt completely.
Correct Answer: C
The market equilibrium occurs where MPB=MPC. Since MSB > MPB, the market produces too little. For all the units between the market quantity and the socially optimal quantity, the MSB is greater than the MSC. These units would have added to total economic surplus but are not produced, creating a deadweight loss.
A) prices are set too high for the average consumer.
B) the market mechanism fails to reflect the true social costs or benefits of an activity.
C) they inevitably lead to the creation of monopolies.
D) they only occur in markets for non-excludable goods.
Correct Answer: B
The content explains that 'private markets do not take into consideration social costs or social benefits' because 'rational agents respond to private costs and benefits and not to external costs and benefits.' This failure to reflect true social values is the central issue.
A) It allows the government to publicly provide the good at the socially optimal quantity.
B) It creates a legal framework where the party creating a negative externality can be sued for damages by the affected party, forcing them to internalize the cost.
C) It guarantees that all goods become non-excludable, leading to a free-rider problem.
D) It subsidizes the production of goods with positive externalities by transferring property from one group to another.
Correct Answer: B
By assigning a property right (e.g., the right to clean air or water), the law allows the owner of that right to negotiate with the polluter or take legal action. This forces the agent creating the externality to consider the external cost, either through payment or by changing their behavior, effectively internalizing the externality.
A) the marginal social cost of their production.
B) their private costs and benefits of production.
C) the incentive to free ride on the clean river.
D) a government subsidy for pollution.
Correct Answer: B
The content states, 'rational agents respond to private costs and benefits and not to external costs and benefits.' The factory owners, as rational agents, will make production decisions based on their own costs (labor, materials) and benefits (revenue), not the external cost of pollution imposed on the fishing business.
A) The market price will decrease and the quantity produced will decrease.
B) The demand curve will shift to the left, and total economic surplus will decrease.
C) The quantity produced will increase to the point where marginal social benefit equals marginal social cost.
D) The supply curve will shift to the left, and the market will produce at the socially optimal level.
Correct Answer: C
A positive externality means the market underproduces. A corrective policy like a subsidy aims to increase production. The goal is to reach the socially optimal quantity, which is defined as the point where MSB = MSC. This policy increases total economic surplus by eliminating the deadweight loss.
A) government must always intervene with taxes or subsidies to correct externalities.
B) if transaction costs are low, private parties can sometimes negotiate a solution to an externality problem without government intervention.
C) externalities can only be solved by making all goods public goods.
D) the free-rider problem makes private solutions impossible.
Correct Answer: B
This policy option, along with the mention of 'high transaction costs' as a cause of externalities, points to the idea that private bargaining can reassign rights (e.g., a polluter pays the victim, or the victim pays the polluter to stop). This is feasible when the costs of negotiating (transaction costs) are not prohibitively high.
A) they are produced in a perfectly competitive market.
B) they generate benefits for third parties and society beyond the private benefits to the individual consumer.
C) their production costs are fully borne by the individual consumer.
D) they are non-excludable, leading to a free-rider problem.
Correct Answer: B
This is a direct application of the definition of a positive externality. An educated populace and high vaccination rates create benefits for society (e.g., a more productive workforce, herd immunity) that are not captured by the individual who gets the education or shot. The private market, therefore, would not produce the socially optimal amount.