Public Goods & Externalities Practice Questions

8 representative multiple-choice questions on public goods & externalities for AP Microeconomics, drawn from our 15-question bank for this module. Work through each one, then open “Show answer” for the correct choice and an explanation. For scored, timed practice across the full bank, take a full practice test.

1. 1. A chemical plant dumps waste into a river, harming downstream fisheries. This is an example of:

   • A. A positive externality, because the plant creates jobs
   • B. A negative externality, because third parties bear uncompensated costs
   • C. A public good, because the river is non-excludable
   • D. The free-rider problem, because fishers are free-riding on the plant
   Show answer

   Correct answer: B. A negative externality, because third parties bear uncompensated costs

   The fisheries bear genuine costs (contaminated water, damaged catch) from production they were never part of. Negative externality by definition. (A) confuses the plant's employment with the pollution spillover; jobs are a private market outcome, not the externality at issue. (D) gets the relationship completely backwards; the fishers are victims of the pollution, not free-riders benefiting from the plant.

2. 2. When a positive externality exists, the market equilibrium quantity is:

   • A. Greater than the socially optimal quantity
   • B. Equal to the socially optimal quantity
   • C. Less than the socially optimal quantity
   • D. Indeterminate without more information
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   Correct answer: C. Less than the socially optimal quantity

   Social benefit exceeds private benefit. Buyers weigh only their own gain, so they purchase less than society would want. Underproduction. (A) describes negative externalities, which is the overproduction case.

3. 3. Which of the following is the best example of a public good?

   • A. A toll road with electronic payment
   • B. A Netflix subscription
   • C. National defense
   • D. A loaf of bread from a bakery
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   Correct answer: C. National defense

   National defense is non-rival (protecting one citizen doesn't reduce protection for anyone else) and non-excludable (you can't selectively leave some citizens undefended). Toll roads are excludable because non-payers get blocked at the booth. Netflix is excludable through login credentials. Bread is both rival and excludable. Private good through and through.

4. 4. According to the Coase theorem, private negotiation can resolve externalities efficiently when:

   • A. The government imposes a Pigouvian tax
   • B. Property rights are well-defined and transaction costs are low
   • C. There are many parties involved in the externality
   • D. The externality is positive rather than negative
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   Correct answer: B. Property rights are well-defined and transaction costs are low

   Clear property rights plus low bargaining costs are the two conditions Coase requires. Parties negotiate their way to efficiency without government intervention. (A) is Pigou's approach, not Coase's. (C) actually undermines Coasean bargaining; more parties means higher transaction costs, which is exactly what causes the theorem to fail.

5. 5. Vaccines generate significant positive externalities. Without government intervention, the market price of vaccines will be _____ and the quantity will be _____ compared to the social optimum.

   • A. Too high; too low
   • B. Too low; too high
   • C. Too high; too high
   • D. Too low; too low
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   Correct answer: A. Too high; too low

   With a positive externality, marginal social benefit exceeds marginal private benefit. The market only reflects private benefit, settling at a price that's too high relative to social value (which prices out buyers who would generate genuine social gains) and a quantity that falls short of the optimum. A subsidy would lower the effective price and push quantity toward where society wants it. (B) describes the negative externality pattern, which is the reverse.

6. 6. Overgrazing on public pastureland is an example of the 'tragedy of the commons.' This occurs because the pastureland is:

   • A. Non-rival and non-excludable, like a public good
   • B. Rival and excludable, like a private good
   • C. Rival but non-excludable, so each herder has an incentive to overuse the resource
   • D. Non-rival but excludable, like a club good
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   Correct answer: C. Rival but non-excludable, so each herder has an incentive to overuse the resource

   Common resources are rival (one cow eating the grass leaves less for the next cow) but non-excludable (herders can't be fenced out of open pasture). Each herder captures the full private benefit of adding another cow but shares the overgrazing damage with everyone else. That lopsided incentive drives overuse even though collective restraint would make everyone better off, which is exactly what Garrett Hardin described in his 1968 essay. (A) is wrong because if the pasture were non-rival, overgrazing wouldn't be an issue in the first place.

7. 7. Governments provide public goods primarily because:

   • A. Public goods are always cheaper for governments to produce than for private firms
   • B. The free-rider problem causes private markets to underprovide goods that society values
   • C. Citizens prefer government-produced goods to privately produced goods
   • D. Public goods generate negative externalities that only governments can regulate
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   Correct answer: B. The free-rider problem causes private markets to underprovide goods that society values

   The free-rider problem is the market failure that triggers government involvement. Non-excludability means private firms can't charge users, so the good gets underproduced or never produced at all. Governments use compulsory taxation to solve the revenue problem: everyone pays, everyone benefits. (A) is wrong because governments aren't necessarily cheaper producers; the issue is revenue collection, not production cost. (D) confuses public goods with externalities, which are two different concepts entirely.

8. 8. The marginal social benefit of a public good is determined by:

   • A. The benefit to the single consumer who values it most
   • B. The average benefit across all consumers
   • C. The vertical summation of all individual consumers' marginal benefit curves
   • D. The horizontal summation of all individual consumers' marginal benefit curves
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   Correct answer: C. The vertical summation of all individual consumers' marginal benefit curves

   Public goods are non-rival, meaning every consumer enjoys the same unit at the same time. To find total social benefit at any given quantity, you add up what each person is willing to pay for that unit. That's vertical summation. This is different from private goods, where market demand comes from horizontal summation (adding quantities at each price). (D) is the private good method. (A) captures only one person's valuation and ignores everyone else who also benefits simultaneously. (B) is a statistical average that doesn't correspond to any standard aggregation procedure in economics.