Chapter 13, Problem 3E

To determine

(a)

Calculation of external cost per unit.

Answer to Problem 3E

The external cost per unit of output is $2.

Explanation of Solution

Quantity	Private Cost	Private Marginal Cost (PMC)	Social Cost	Social Marginal cost (SMC)	Benefit	Marginal Benefits (MB)	External Cost
1	2	0	4	0	12	12	2
2	6	4	10	6	22	10	4
3	12	6	18	8	30	8	6
4	20	8	28	10	36	6	8
5	30	10	40	12	40	4	10

Note- External cost = Social Cost − private cost.

Economics Concept Introduction

Externalities: The externalities arise when the consumption of goods and services impact other people directly or indirectly. However, the nature of impact determines the type of externalities (positive externality or negative externality).

To determine

(b)

The level of output to produce.

Explanation of Solution

Quantity	Private Cost	Private Marginal Cost (PMC)	Social Cost	Social Marginal cost (SMC)	Benefit	Marginal Benefits (MB)	External Cost
1	2	0	4	0	12	12	2
2	6	4	10	6	22	10	4
3	12	6	18	8	30	8	6
4	20	8	28	10	36	6	8
5	30	10	40	12	40	4	10

The level of output to produce is determined where its PMC = MB. So, at 3.5 unit the PMC is 7 (producing of extra unit the PMC is $2. So, PMC for producing 0.5 unit is $1.)which equal to the marginal benefit of $7 (the value between 8 and 6 in MB column).

Economics Concept Introduction

Externalities: The externalities arise when the consumption of goods and services impacts other people directly or indirectly. However, the nature of impact determines the type of externalities (positive externality or negative externality).

To determine

(c)

The level of output at which economic efficiency is to achieved.

Explanation of Solution

Quantity	Private Cost	Private Marginal Cost (PMC)	Social Cost	Social Marginal cost (SMC)	Benefit	Marginal Benefits (MB)	External Cost
1	2	0	4	0	12	12	2
2	6	4	10	6	22	10	4
3	12	6	18	8	30	8	6
4	20	8	28	10	36	6	8
5	30	10	40	12	40	4	10

The level of output to achieve economic efficiency exists at a point where its social marginal cost is equal to its marginal benefits (SMC = MB). So, the output level for economic efficiency is 3.

Economics Concept Introduction

Externalities: The externalities arise when the consumption of goods and services impact other people directly or indirectly. However, the nature of impact determines the type of externalities (positive externality or negative externality).

To determine

(d)

Explanation of Solution

Quantity	Private Cost	Private Marginal Cost (PMC)	Social Cost	Social Marginal cost (SMC)	Benefit	Marginal Benefits (MB)	External Cost
1	2	0	4	0	12	12	2
2	6	4	10	6	22	10	4
3	12	6	18	8	30	8	6
4	20	8	28	10	36	6	8
5	30	10	40	12	40	4	10

At point 3.5; the difference between successive external cost is $1 (by interpolating $7-$6) per 0.5 unit or the value they are willing to give up is $6 for manufacturing only 3 units instead of 3.5 units.

Economics Concept Introduction

Externalities: The externalities arise when the consumption of goods and services impacts other people directly or indirectly. However, the nature of impact determines the type of externalities (positive externality or negative externality).