703
Externalities
nality cost (i.e., MSC f = MPC f + MEC f). The vertical distance between the MPC f and MSC f curves is the marginal externality cost of producing the good. If the externality cost of the firm depicted in Figure 15.6 is typical of all firms in the industry, then the MSC i curve in Figure 15.7 lies above the MPCi curve. The socially efficient level of output occurs when each firm in the industry incurs the full costs of producing the product. This is illustrated in Figure 15.7 at the output level Q1i, where the MSC i curve intersects the industry demand curve, DD. The socially efficient price is P1. It is apparent from Figures 15.6 and 15.7 that when firms ignore externality costs, there is an inefficiently high level of production. The oversupply of the product is illustrated in Figure 15.7 as the distance Q0i–Q1i. The welfare cost to society is also illustrated in Figure 15.7. This cost is given by the shaded area FGE, which measures the difference between the marginal social cost and marginal social benefit for each unit of overproduction. Problem 15.2. Suppose that the marginal private cost of producing fertilizer is MPC = 4Q Suppose further that the marginal externality cost of the pollution emitted is MEC = 2Q Finally, suppose that market demand for fertilizer is given as Q = 50 - 0.25P a. Find the perfectly competitive price and output level. b. If this industry were dominated by a single firm, what would be the profit-maximizing price and output level? c. Find the socially optimal price and output level. Solution a. A perfectly competitive industry will produce at an output level at which marginal private cost equals price, MPC = P. Solving the demand equation for price yields P = 200 - 4Q Substituting MPC = P 4Q = 200 - 4Q Q* = 25 P* = 200 - 4(25) = $100
