Question

Explain the concept of externality as it relates to the supply of a product. If the externality is negative, what would this imply about the private versus the social supply curve (marginal social cost curve).

Answer 1

Answer - Externality can be understood as the impact a certain activity has upon the third party. Such an impact is unintended. In the case of positive externality , the supply of the product will be lesser or equal to socially optimal level. In the case of negative externality , the output will be greater than the socially optimal level.

In the case of the negative externality such as pollution , the negative impacts have to faced by the society. Thus , the Social cost of the negative externality is greater than the private cost of externality. The output in this case is greater than the socially optimal level of output , and the Marginal social cost curve lies above the supply curve at all the quantities because of the additional cost of externality that the society has to face.