Comment on the following statement: When a negative externality ...

[ss2343]

Comment on the following statement: When a negative externality is present, and a firm does not factor the additional social cost into its decisions, the firm is likely to produce a level of output that is lower than the efficient level.
 
  What will be an ideal response?

Question 2

Refer to Figure 13-3. Suppose the economy is at point A. If investment spending increases in the economy, where will the eventual long-run equilibrium be?
 
  A) A B) B C) C D) D

[spencer.martell]

Answer to Question 1

The statement is false. When a negative externality is present, the true marginal cost of producing the good is higher than the marginal cost the firm bears. Firms in perfect competition will produce where price is equal to marginal cost (that the firm bears). Thus, the firm is producing a level of output for which the true cost (private + external cost) is greater than the price. This means that the level is output is greater than the efficient level of output.

Answer to Question 2

C