ACA ICAEW Business Strategy and Technology Practice Exam

Externalities refer to the social costs or benefits that are not reflected in the market price of goods or services, impacting third parties who are not directly involved in an economic transaction. The correct choice highlights that external costs (negative externalities) and benefits (positive externalities) can indeed be addressed and mitigated through regulation.

For instance, a factory that pollutes the environment incurs a cost that is not borne solely by the factory owners but instead affects local communities and ecosystems. Government regulations, such as pollution taxes or permits, can help internalize these external costs, incentivizing producers to reduce their negative impact on society. Similarly, positive externalities, such as education or vaccination, may require government support to ensure that the benefits are widely enjoyed and that the productive resources are allocated efficiently.

The focus on regulation as a means to manage externalities is also rooted in the idea that purely market-driven transactions may overlook these social impacts, thus leading to market failures. While the other options touch upon concepts related to market dynamics, they do not accurately capture the essential nature of externalities and the role regulation plays in addressing them.