If the production of computer chips yields greater technology spillovers than the production of potato chips, the government should
a. encourage the production of computer chips with subsidies.
b. discourage the production of potato chips with taxes.
c. encourage the production of potato chips with subsidies.
d. discourage the production of computer chips with taxes.
The correct answer and explanation is:
Correct Answer: a. encourage the production of computer chips with subsidies.
When the production of a good generates positive externalities, such as technology spillovers, it benefits not only the producer and consumer but also other firms and sectors. These spillovers can come in the form of shared innovations, increased productivity, and the advancement of industry-wide knowledge. This is especially common in high-tech industries like the computer chip sector, where developments in hardware design, processing power, and manufacturing techniques can benefit other industries such as software development, telecommunications, and artificial intelligence.
Since these external benefits are not captured in the market price, private firms may produce less of the good than is socially optimal. In economic terms, the marginal social benefit (MSB) of production exceeds the marginal private benefit (MPB). This underproduction leads to a market failure, which justifies government intervention.
One effective way for the government to correct this underproduction is through subsidies. By subsidizing computer chip production, the government reduces the cost for producers, encouraging them to produce more. This brings the private production level closer to the socially optimal level, increasing both private and public benefits from the spillovers.
In contrast, potato chip production typically does not result in significant technology spillovers. Therefore, there is no justification for either subsidizing or taxing potato chips unless there are other externalities involved, such as health or environmental effects.
Taxing potato chips or computer chips in this scenario would be counterproductive. Taxing potato chips would not necessarily increase computer chip production, and taxing computer chips would further reduce their production, worsening the underproduction caused by positive externalities.
Thus, the best policy is to encourage computer chip production with subsidies to maximize the benefits of technology spillovers.