Question

Explain why internalizing an externality may be economically efficient, but not necessarily socially just. In your answer, refer to (and draw) such concepts as net social benefit, deadweight loss, consumer and producer surplus.

Answer 1

Internalizing an negative externality is economically efficient and benefit a private person but it is not good for the society as a whole. You can see in the diagram below that private efficient level of output is more than social efficient level of output because marginal private cost is less than marginal social cost or we can say that private producers pose harm to society when producing a good. For example: playing DJ in night for house party may be entertaining for party people while its harms students studying in nearby home.

	Private efficient outcome	Socially efficient outcome
Price charged	Pp	Ps
Consumer surplus	A + B + C + D	A
Producer Surplus	E + F + G	B + E
Deadweight loss	Shaded area in above diagram	-