If a good generates an external cost, the market will produce: a.) Too much of the...

If a good generates an external cost, the market will produce:

a.) Too much of the good.
b.) Some of the good but not enough.
c.) None of the good.
d.) An optimal amount of the good.

Expert Solution

Ans) Option A

Negative externality refers to the negative effects that the action of an individual or a firm has on the society as a whole.

The private marginal cost refers to the additional cost incurred in the production of an extra unit of a good.

It is shown in the diagram and is upward sloping line meaning that as the production of a good increases, the marginal cost of good is increasing.

The other girl in the diagram is the private marginal benefit curve and the equilibrium occurs where the marginal cost equals the marginal benefit. This is the optimal point from an individual point of view.

Social optimal Point

There is one more equilibrium which is based on the welfare of the whole society. To find that we first need to find the social marginal cost which is equal to the private marginal cost plus the external cost at each level of output.

The social marginal cost is represented by the red line in the diagram.

Social optimal equilibrium occurs where the social marginal cost intersects the marginal benefit curve.

Social optimal quantity is less than that produced at a private optimal point.

Therefore it can be concluded that when there is a negative externality, more of a good is produced.

Rahul Sunny answered 1 year ago

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