Consider a good with external benefits. Which of the following best describes why the market does not produce an allocatively efficient amount?Select an answer and submit. For keyboard navigation, use the up/down arrow keys to select an answer.aThe marginal private cost of production equals both the marginal private benefit of production and the marginal social benefit of production.bThe marginal private cost of production equals the marginal private benefit of production but is less than the marginal social benefit of production.cThe marginal private cost of production exceeds the marginal social benefit of production but equals the marginal private benefit of production.dThe marginal private benefit of production exceeds both the marginal private cost of production and the marginal social benefit of production.
Question
Consider a good with external benefits. Which of the following best describes why the market does not produce an allocatively efficient amount?Select an answer and submit. For keyboard navigation, use the up/down arrow keys to select an answer.aThe marginal private cost of production equals both the marginal private benefit of production and the marginal social benefit of production.bThe marginal private cost of production equals the marginal private benefit of production but is less than the marginal social benefit of production.cThe marginal private cost of production exceeds the marginal social benefit of production but equals the marginal private benefit of production.dThe marginal private benefit of production exceeds both the marginal private cost of production and the marginal social benefit of production.
Solution
The correct answer is b. The marginal private cost of production equals the marginal private benefit of production but is less than the marginal social benefit of production.
Here's why:
In a market with external benefits, the social benefit of a good (which includes both the private benefit and the external benefit) is greater than the private benefit alone. Producers, however, only take into account the private benefit when deciding how much to produce, not the external benefit.
Therefore, the marginal private cost of production (what it costs the producer to make one more unit of the good) equals the marginal private benefit (the additional benefit the producer gets from selling one more unit of the good), but is less than the marginal social benefit (the total benefit to society from producing one more unit of the good, including both the private benefit and the external benefit).
This means that the market on its own will not produce enough of the good to be allocatively efficient, because it does not take into account the external benefits. Allocative efficiency is achieved when the marginal cost of production equals the marginal social benefit, not just the marginal private benefit.
Similar Questions
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