Net Social Gain from Moving to a Pareto-Efficient Outcome
When production with a negative externality is reduced from the privately optimal level (Point A) to the Pareto-efficient level (Point B), a net social gain is created. This gain arises because the producers' loss in profits is smaller than the welfare gain for the third party affected by the externality. Graphically, this net social gain is represented by the area between the marginal social cost curve and the price line, from the efficient quantity to the inefficient quantity. The existence of this surplus provides a basis for a potential bargain.
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Ch.10 Market successes and failures: The societal effects of private decisions - The Economy 2.0 Microeconomics @ CORE Econ
The Economy 2.0 Microeconomics @ CORE Econ
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A firm's production process creates a negative externality. The market price for its product is fixed at P. The firm's marginal private cost is represented by an upward-sloping MPC curve, and the marginal social cost is represented by an upward-sloping MSC curve, which lies above the MPC.
- Point 'a' is where the Price line intersects the MPC curve, at quantity Qp.
- Point 'b' is where the Price line intersects the MSC curve, at quantity Qs.
- Point 'c' is the point on the MPC curve at quantity Qs.
- Point 'd' is the point on the MSC curve at quantity Qp.
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A company's production imposes a cost on a third party. The company sells its product at a constant market price. The company's marginal cost to produce an additional unit (its private cost) increases with output, while the marginal cost to society (which includes the cost to the third party) is always higher than the company's private cost. Suppose the company is required to reduce its output from the level that maximizes its own profit to the socially efficient level. True or False: The company's total loss in profit from this reduction is equal to the total reduction in cost experienced by the third party.
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A firm's production process creates a negative externality. The market for its product is described by the following elements:
- A horizontal line represents the fixed market Price (P).
- An upward-sloping curve represents the firm's Marginal Private Cost (MPC).
- Another upward-sloping curve, which lies above the MPC, represents the Marginal Social Cost (MSC).
Key points are defined as follows:
- Point
e: The intersection of the Price line and the MSC curve (at the socially optimal quantity, Qs). - Point
f: The intersection of the Price line and the MPC curve (at the privately optimal quantity, Qp). - Point
g: The point on the MPC curve directly below pointe(at quantity Qs). - Point
h: The point on the MSC curve directly above pointf(at quantity Qp).
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In a market diagram where a firm's production generates a negative externality, if the firm is compelled to reduce its output from its private profit-maximizing level to the socially efficient level, the resulting loss in its total profit is graphically represented by the area between the horizontal price line and the firm's ___________ curve, bounded by the two output levels.
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Learn After
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