When production or consumption of a product causes negative effects on third parties, we say that

Question

BlackTom AI · Accepted Answer

Negative externalities occur when private production or consumption imposes extra costs on third parties; the market equilibrium ignores these external costs. Key concepts: private marginal cost (PMC or MPC), marginal social cost (MSC = MPC + external cost), marginal benefit (MB). A competitive market equates MPC to MB, but the socially optimal outcome equates MSC to MB.

Step-by-step reasoning:
1. Let MPC be the firm’s private cost curve and MB the demand curve. In an unregulated market, firms produce where MPC = MB at quantity Q_market.
2. When a negative externality exists (e.g., pollution), each unit produced generates an external cost (MEC > 0). Thus MSC = MPC + MEC, so MSC lies above MPC at every quantity.
3. The social optimum is where MSC = MB. Because MSC > MPC for any positive MEC, the MSC = MB intersection occurs at a smaller quantity Q_social < Q_market.
4. Therefore the market produces Q_market which exceeds the socially optimal quantity; resources are allocated toward producing too much of the good relative to the social optimum. This excess production generates deadweight loss equal to the area between MSC and MB for units between Q_social and Q_market.
5. Policy to correct this typically raises the private marginal cost (e.g., a Pigouvian tax equal to MEC), shifting MPC up to MSC and reducing quantity to Q_social.

Why the correct answer is correct:
- Option d states there is an over-allocation of resources toward this product, which directly describes Q_market > Q_social caused by ignored external costs.

Why other options are incorrect:
- a (subsidy) would encourage more consumption/production and worsen the externality.
- b (price must be too high) is wrong: the private market price is typically too low relative to the true social cost.
- c (equilibrium quantity is too low) is the opposite of the truth; the equilibrium quantity is too high.

Conclusion: The correct choice is d. This matches the provided answer.

When production or consumption of a product causes negative effects on third parties, we say thatSingle choice

Similar Questions

When production or consumption of a product causes negative effects on third parties, we say that

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