Consider a market where production creates costs for society that are not paid by the producers. The graph for this market includes an upward-sloping Marginal Private Cost (MPC) curve and an upward-sloping Marginal Social Cost (MSC) curve, with the MSC curve positioned above the MPC curve. A constant market price is shown as a horizontal line. The unregulated market produces at Point A, where the price line intersects the MPC curve. The socially efficient production level is at Point B, where th

In a negotiation between a town's residents and a local factory, the residents have full bargaining power. They can set the level of environmental quality the factory must adhere to, but the factory will shut down if it cannot make at least zero economic profit. Which outcome will the residents choose to maximize their own well-being?

Calculating Social Welfare Gains from Production Changes

In a market with a negative production externality, reducing output from the privately optimal level to the socially optimal level creates a net social gain because the producers' loss of profit is exactly equal to the reduction in external costs imposed on third parties.

In a market where production generates costs for a third party, output is reduced from the privately optimal level (where price equals marginal private cost) to the socially optimal level (where price equals marginal social cost). Match each economic concept related to this change with its corresponding graphical representation, defined over the range of output that is eliminated.

Explaining the Net Social Gain from Correcting an Externality

The Economic Rationale for Negotiated Solutions to Externalities

Bargaining Over a Negative Externality

Calculating Net Social Gain from Externality Reduction

Calculating Welfare Changes from Externality Correction