Which policy instrument is commonly used to correct a positive externality in consumption?

• A. A per-unit tax on consumption
• B. A per-unit subsidy to encourage consumption
• C. A price ceiling on consumption
• D. A ban on consumption

Answer: (B)

When a positive externality exists in consumption, the social value of consuming an extra unit exceeds the private value to the consumer, so the market tends to underproduce relative to the socially optimal level. A per-unit subsidy to consumers increases the private benefit they receive for each unit consumed, effectively raising their willingness to pay by the subsidy amount. This shifts the demand curve outward, leading to higher consumption and moving the outcome closer to the social optimum.

Other instruments don’t fit this goal. A per-unit tax would discourage consumption and deepen the underconsumption problem. A price ceiling lowers the price but isn’t a targeted way to internalize the extra social benefit and can cause shortages or misallocation. A ban on consumption simply reduces or eliminates consumption, worsening the misalignment with social value.