Answer to Question #224414 in Microeconomics for Gurjot

Question

In the course of paper production, factories discharge a large amount of wastewater into rivers, causing decreasing population of fish and contamination of public water-supply system. Assume the rest of the society bears $10 in pollution damages for every unit of paper produced. Draw the marginal social cost curve on the above diagram, and calculate the socially efficient equilibrium. Briefly discuss how the existence of external costs makes market equilibrium to be different from a socially efficient equilibrium.

Answer 1

marginal external cost = $10 this means that social cost to produce every unit of the good is $10 more than the private cost.

Graphically that would lead to an upward shift of the supply curve by $10 at each unit of the good.

50 40 30 (20.30) 20 10. 10 20 30 40 50

It is right to think that the marginal social cost curve would start from 0 because at 0 levels of production there is no external cost, but even if there is fractional production of the good, there will be an external cost associated with the production. Except for the point (x = 0, y = 0) on the graph, the marginal social cost curve will be vertically higher by $10 from the marginal private cost curve. Since 0 levels of production is not what we deal with, we graphically depict the marginal social cost curve as above.