A shift from S1 to S2 reflects the change that happens when a negative externality is taken into account. A shift from D1 to D2 reflects the change that happens when a positive externality is taken into account.
-Refer to the above figures. Externalities exist in both panels. After correcting for the externalities the prices should be
A) P1 and P3.
B) P1 and P4.
C) P2 and P4.
D) P2 and P3.

Question

A shift from S1 to S2 reflects the change that happens when a negative externality is taken into account. A shift from D1 to D2 reflects the change that happens when a positive externality is taken into account.
-Refer to the above figures. Externalities exist in both panels. After correcting for the externalities the prices should be
A) P1 and P3. 
B) P1 and P4. 
C) P2 and P4. 
D) P2 and P3.

Quizplus · Accepted Answer

In panel 1, correcting for the negative externality would shift the supply curve from S1 to S2, resulting in a higher equilibrium price at P2. However, correcting for the positive externality would also shift the demand curve from D1 to D2, resulting in an even higher equilibrium price at P4.

In panel 2, correcting for the negative externality would shift the supply curve from S1 to S2, resulting in a higher equilibrium price at P2. Correcting for the positive externality would not have an effect on the equilibrium price, as the demand curve would not shift.

Therefore, the only choice that includes the correct prices after accounting for both externalities is C) P2 and P4.

A Shift from S1 to S2 Reflects the Change That