Scenario: The production of a good creates a negative externality. The following figure shows the market for this good.

-Refer to the scenario above.The socially optimal level of output for this good is ________,while the market produces ________.
A) Q₁; Q₂
B) Q₁; Q₃
C) Q₂; Q3
D) Q₂; Q₁

Question

Scenario: The production of a good creates a negative externality. The following figure shows the market for this good.
 
-Refer to the scenario above.The socially optimal level of output for this good is ________,while the market produces ________.
A) Q₁; Q₂ 
B) Q₁; Q₃ 
C) Q₂; Q3 
D) Q₂; Q₁

Quizplus · Accepted Answer

The socially optimal level of output is where the marginal social cost (MSC) equals the marginal social benefit (MSB), which occurs at point Q₁. However, the market equilibrium occurs where the marginal private benefit (MPB) equals the marginal private cost (MPC), which occurs at point Q₂. Thus, the market produces less than the socially optimal level and there is a deadweight loss represented by the shaded triangle. Therefore, to achieve the socially optimal level of output, either the government can intervene with a tax equal to the external cost or provide a subsidy equal to the external benefit, or private parties can negotiate and internalize the externality through Coase Theorem.

Scenario: the Production of a Good Creates a Negative Externality