Reference: Ref 10-2 (Figure: Market with External Cost) Suppose that the figure displays the demand and supply curves for dry cleaning, a service that creates pollution. The external cost of dry cleaning is:
A) P2.
B) P1 - P0.
C) P0.
D) P2 - P0.

Question

Reference: Ref 10-2 (Figure: Market with External Cost) Suppose that the figure displays the demand and supply curves for dry cleaning, a service that creates pollution. The external cost of dry cleaning is:
A) P2. 
B) P1 - P0. 
C) P0. 
D) P2 - P0.

Quizplus · Accepted Answer

The external cost of dry cleaning is the difference between the social cost (including both private cost and external cost) and the private cost. In this diagram, the private cost is represented by the supply curve (S), while the social cost is represented by the marginal social cost curve (MSC). The external cost is the vertical distance between the MSC and the supply curve at the quantity Q*. This distance is equal to P2 - P0, which is represented by the shaded area in the diagram. Therefore, the correct answer is (D) P2 - P0.

Reference: Ref 10-2 (Figure: Market with External Cost) Suppose That