Which of the following statements are correct?
(A) Smoke from a factory that harms the health of nearby residents is a negative externality.
(B) A firm causing a negative externality compensates the people it harms.
(C) A well-kept private garden that the neighbours also enjoy is a positive externality.
(D) When there are positive externalities, GDP underestimates the actual welfare.
(E) Externalities are bought and sold in their own markets.
Choose the correct answer from the options given below:
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → (A), (C) and (D) only
Externalities are benefits or harms one person or firm causes to others, for which it is not paid or penalised. They have no market.
(A) Smoke from a factory that harms the health of nearby residents is a negative externality. — True. Harm to residents’ health is a negative externality.
(B) A firm causing a negative externality compensates the people it harms. — False. The firm is not penalised; it bears no cost for the harm.
(C) A well-kept private garden that the neighbours also enjoy is a positive externality. — True. A benefit to neighbours for which the owner is not paid is a positive externality.
(D) When there are positive externalities, GDP underestimates the actual welfare. — True. With positive externalities, GDP underestimates welfare.
(E) Externalities are bought and sold in their own markets. — False. Externalities do not have any market in which they can be bought and sold.
NCERT (2026-27): “2.5 GDP and Welfare … 3. Externalities: Externalities refer to the benefits (or harms) a firm or an individual causes to another for which they are not paid (or penalised). Externalities do not have any market in which they can be bought and sold. …” “2.5 GDP and Welfare … Such harmful effects that the refinery is inflicting on others, for which it will not bear any cost, are called externalities. In this case, the GDP is not taking into account such negative externalities. Therefore, if we take GDP as a measure of welfare of the economy we shall be overestimating the actual welfare. This was an example of negative externality. There can be cases of positive externalities as well. In such cases, GDP will underestimate the actual welfare of the economy.” |