Figure 5-2

Figure 5-2 shows a market with a negative externality.
-Refer to Figure 5-2.The marginal benefit of the last unit produced is represented by the price

Question

Figure 5-2
  
Figure 5-2 shows a market with a negative externality.
-Refer to Figure 5-2.The marginal benefit of the last unit produced is represented by the price

Quizplus · Accepted Answer

The marginal benefit of the last unit produced is represented by the demand curve, which in this case is PB. This is because the price represents the willingness of consumers to pay for each unit of the good, and as the quantity produced increases, the marginal benefit decreases (as represented by the downward slope of the demand curve). Therefore, the optimal level of production is where marginal cost (MC) equals marginal benefit (MB), which is at Q*. However, the market is producing at Q₀, which is excessive and results in a negative externality (represented by the vertical distance between the demand curve and the social cost curve at Q₀). To decrease the negative externality and achieve the optimal level of production, a corrective tax equal to the distance between Pb and Pc should be imposed on producers (or a cap-and-trade system could be implemented). This would increase the marginal cost and decrease the quantity produced to Q*, which maximizes social welfare.

Figure 5-2 Figure 5-2 Shows a Market with a Negative Externality