Question

On a graph, compare the market price for the good where the negative externality exists, and what the market would look like if the externality were internalized. Describe briefly. Please Provide two separate graphs (one before internalization and one after) and describe what actions what must be taken to internalize and thus create the second graph that shows the negative externality specifically.

Answer 1

Graph i depicts the case of negative externality before the externality is internalized. In this case, the privately efficient equilibrium occurs at point E1 and socially efficient equilibrium occurs at point E2. Thus, private quantity is above the socially efficient quantity in the case of negative externality.

In order to internalize the externality, taxes needs to be imposed on the producers so that marginal private cost shifts upwards to MPC + Tax as depicted in graph (ii) and privately efficient equilibrium is same as socially efficient equilibrium at point E2 and the externality has been internalized.