Discussion
When there are negative externalities:
Answer: A
A negative externality is a cost imposed on third parties who are not part of the transaction, so the marginal social cost is the private marginal cost of the producer plus the external cost. This makes the marginal social cost higher than the marginal (private) cost. If it were lower or equal, there would be no negative externality, and a marginal social benefit equal to marginal cost describes the efficient outcome. The answer is option A. The gap between the two is the external cost, and it is why a tax equal to that gap can restore efficiency, as Pigou argued.
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