Figure 5-1 Figure 5-1 shows a market with an externality. The current market equilibrium output of Q₁ is not the economically efficient output. The economically efficient output is Q₂.
-Refer to Figure 5-1.If,because of an externality,the economically efficient output is Q₂ and not the current equilibrium output of Q₁,what does S₂ represent?

Question

Figure 5-1

Figure 5-1 shows a market with an externality. The current market equilibrium output of Q₁ is not the economically efficient output. The economically efficient output is Q₂.
-Refer to Figure 5-1.If,because of an externality,the economically efficient output is Q₂ and not the current equilibrium output of Q₁,what does S₂ represent?

Quizplus · Accepted Answer

S₂ represents the market supply curve reflecting social cost, which takes into account the external cost of the externality. As a result, the socially optimal equilibrium output is at the intersection of the demand curve and the social cost curve, where marginal social benefit equals marginal social cost.

Figure 5-1 Figure 5-1 Shows a Market with an Externality