What divergences arise between equilibrium and output and efficient output when (10) a) negative externalities and b) positive externalities are present?

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Business

Johnny Burke

4 July, 06:30

What divergences arise between equilibrium and output and efficient output when (10) a) negative externalities and b) positive externalities are present?

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Alexandra Baxter · Answer 1

Production or consumption activities lead to an external cost for the third party, which causes the social marginal cost to exceed the private marginal cost. Consumers and producers base their decisions on private marginal cost and there would be an overproduction or excessive consumption of the good. The balance output is more than the efficient output.

Taxes must be imposed to correct the divergence between social and private marginal costs.

On the other hand, production or consumption leads to an external benefit for the third party, which means that the marginal social benefit exceeds the private marginal benefit. Consumers and producers base their decision on private marginal benefit and there would be underproduction or low consumption of the good. The balance output is less than the efficient output. The government would have to provide subsidies to producers or consumers to correct these inefficiencies.