Question

Explain the effects of externalities on

private cost

social cost

social benefits

Explain how externalities affect the level of output of goods and services

Answer 1

Externality is an additional cost incurred by consumption or production of a good.

Private Cost: The private cost is cost incurred for producing a good which do not get affected by an externality.

Social Cost: The private cost plus additional cost incurred by producing or consuming a good increase the externality which results in increased social cost.

Social benefit: As the Social cost increases the price of the good too increases which results in reduced quantity consumed resulting losses

The optimal quantity is where social cost intersects with social benefit which is at lower quantity because of increased cost associated with an externality. So externalities results in increased cost thereby discourages consumption which results in reduced quantity and services being consumed.