Figure: Model of a Competitive Market
(Figure: Model of a Competitive Market) Given the figure Model of a Competitive Market, if there are external costs:
A)resources will be underallocated to the production of the good.
B)resources will be overallocated to the production of the good.
C)resources will be allocated efficiently to the production of the good.
D)the price at P will be higher than if there were no external costs.

Question

Quizplus · Accepted Answer

If there are external costs, the social cost of producing the good is greater than the private cost, which means that the marginal social cost curve (MSC) is above the marginal private cost curve (MPC). In this case, the market will produce Q2 units of the good, which is greater than the socially optimal quantity of Q1 units. Therefore, resources will be overallocated to the production of the good. The price at P will also be lower than the socially optimal price, which means that consumers are not paying the full cost of producing the good.