Suppose that a negative externality is created by the production of good X. Which of the following statements is correct?
A)The social cost of producing good X includes the private cost plus the cost to bystanders of the externality.
B)The increased social cost can be graphed as a decrease in demand.
C)The market equilibrium quantity will be the socially optimal quantity as long as the government does not interfere.
D)Both a and b are correct.

Question

Quizplus · Accepted Answer

A negative externality means that the production of good X imposes costs on third parties (bystanders) who are not involved in the transaction. Therefore, the social cost of producing good X is higher than the private cost paid by the producer. To internalize the externality, the social cost must be taken into account, which means the producer must bear the additional cost of the externality. This can be achieved through government regulation or taxes. Thus, statement A is correct. Statement B is not accurate because the increased social cost results in a leftward shift of the supply curve, not the demand curve. Statement C is incorrect because the market equilibrium quantity will be inefficient and not socially optimal due to the externally imposed cost.

Suppose That a Negative Externality Is Created by the Production