In the context of externalities, what does it mean to "internalize" a cost?

To "internalize" a cost refers to the process of incorporating the external costs of an action into the market price for that action or product. When a cost is internalized, it means that the individual or firm responsible for the externality (like pollution) bears the cost associated with it rather than imposing it on society at large. This often leads to a market price that more accurately reflects the true cost of production or consumption, encouraging more socially desirable behavior.

For instance, if a factory emits pollutants that harm the environment, the costs of that pollution are external to the market price of the factory's products. By implementing mechanisms such as taxes, regulations, or tradable permits, these external costs can be internalized. As a result, the final price of goods will increase, signaling consumers about the detrimental effects of their consumption choices and prompting more sustainable behaviors.

The other options do not accurately capture the essence of internalizing costs. While redistributing wealth, eliminating externalities entirely, or processing legal claims may address issues related to externalities, they do not involve the critical economic principle of adjusting market prices to reflect true costs incurred by society.