Question

Suppose that a steel factory emits a certain amount of air pollution, which constitutes a negative externality. If the market does not internalize the externality,

Select one:

a. the supply curve would adequately reflect the marginal social cost of production.

b. consumers will be required to pay a higher price for steel than they would have if the externality were internalized.

c. the market equilibrium quantity will not be the socially optimal quantity.

d. producers will produce less steel than they otherwise would if the externality were internalized.

Answer 1

Answer is C. the arket quantity will not be the socially optimla quantity.When there is negative externality marginal social cost is higher than marginal private cost as shown in diagram.

Market equilibrium quantity is Q0 and price is P0, but social optimal quantity is Q1 and price is P1. It shows that social optimal quantity is less than market quantity which does not internalize the external cost.

If producer does not internalize the cost he will produce more than social optimal output.

In case of positive externality if producer does not consider social benefits he will produce less than social optimal output.

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