Question

There are no externalities in the market for brim hats; therefore, the:

(a) external marginal cost equals the marginal cost.

(b) equilibrium level of output will be too low.

(c) social benefit equals the external marginal benefit.

(d) social marginal cost equals the private marginal cost.

Answer 1

The correct answer is (d) social marginal cost equals the private marginal cost.

Social marginal cost = External marginal cost + Private marginal cost

or

Social marginal benefit = External marginal benefit + Private marginal benefit

If there is no externality then, External marginal cost = 0

Also, External marginal benefit = 0

That means in the absence of externality, there is no external marginal cost and external marginal benefit, which makes options a and c wrong.

Therefore, Social marginal cost = 0 + Private marginal cost

Social marginal cost = Private marginal cost

Hence option d is correct.