Question

Suppose that cookie producers create a positive externality equal to $2 per dozen. What is the relationship between the equilibrium quantity and the socially optimal quantity of cookies to be produced?
a. They are equal.
b. The equilibrium quantity is greater than the socially optimal quantity.
c. The equilibrium quantity is less than the socially optimal quantity.
d. There is not enough information to answer the question.

Answer 1

Answer:

c. The equilibrium quantity is less than the socially optimal quantity.

Explanation:

Externalities are positive / negative side effects to other parties, which are not monetarily valued & compensated.

Positive Externalities cause extra positive side effect, have extra social benefit apart from private benefit. Their free market unregulated equilibrium under estimates their Total Benefit (considering only private benefit , ignoring social benefit). So the equilibrium quantity is also under estimated. Hence, Equilibrium quantity is less than socially optimal quantity.