Use the following diagram in which S is the market supply curve and S1 is a supply curve comprising all costs of production, including external costs, to answer the question below. Assume that the number of people affected by these external costs is large. If the government wishes to establish an optimal allocation of resources in this market, it should

A. tax producers so that the market supply curve shifts leftward (upward).
B. subsidize consumers so that the market demand curve shifts leftward.
C. not intervene because the market outcome is optimal.
D. subsidize producers so that the market supply curve shifts leftward (upward).

ANSWER

A. tax producers so that the market supply curve shifts leftward (upward).