CA Foundation P4 · Chapter 7 · Question 4 of 15
When the production of a good generates a negative externality such as pollution, the free market will:
Test yourself: pick an answer
Reveal answer & explanation
Correct answer: B) Produce more than the socially optimal quantity, since marginal social cost exceeds marginal private cost
Explanation
The producer considers only private cost, ignoring the external cost borne by others. Since MSC > MPC, the market equates demand with MPC and produces beyond the output where demand equals MSC. The market price is therefore too low and output too high.
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