What will the inclusion of externality do to the market? Explain and use a supply and...

What will the inclusion of externality do to the market? Explain and use a supply and demand graph to show the impact.

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Expert Solution

Below is the graph where there is a negative externality because MSC > MPC

At the market equilibrium the quantity is Q1 and price is P1

At the socially optimal level quantity is Q2 and price is P2

This shows that when the externality (difference between MSC and MPC) is internalized, output is decreased and price is reduced (in case of negative externality)

Here a tax is imposed on producers which shifts the MPC up to MSC to include the external cost.

Rahul Sunny answered 1 year ago

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