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10. (External Costs) Use the data in the table to the right to answer the following questions.

a. What is the external cost per unit of production?
b. What level will be produced if there is no regulation of the externality?

c. What level should be produced to achieve economic efficiency?
d. Calculate the dollar value of the net gain to society from correcting the externality.
Quantity Marginal Marginal Marginal
Private Benefit Private Cost Social Cost
(demand) (supply)

0 - $0 $0
1 $10 2 4
2 9 3 5
3 8 4 6
4 7 5 7
5 6 6 8
6 5 7 9
7 4 8 10
8 3 9 11
9 2 10 12
10 1 11 13


Solution Preview

Question a
In answering this question, I'm assuming that the "Marginal Social Cost" column includes the private cost. Clearly, then, the external cost per unit of production is $2. This can be easily checked: the social cost is the private cost plus the external cost. Since we know what the private costs are, we just subtract the private cost from the social cost; this will be the "external" cost. As you can see, it's constant at $2 per unit.

Question b
When there is no regulation of the externality, market equilibrium is achieved when the marginal private benefit is equal to the marginal private cost. The external costs are not accounted for, because these costs are "dilluted" among many individuals. ...

Solution Summary

The solution answers the question(s) below.