Use this diagram to answer the following questions. PD is private demand. SD is social demand.

The figure above contains:

• A. A positive externality
• B. A negative externality
• C. Both positive and negative externalities
• D. No externalities

Answer: (A)

Verified step by step guidance

1. Identify the curves on the graph: The graph shows two demand curves, PD (Private Demand) and SD (Social Demand), and one supply curve, S.
2. Understand the concept of externalities: A positive externality occurs when the social demand (SD) is greater than the private demand (PD), indicating that the social benefits exceed the private benefits. A negative externality would be the opposite, where social demand is less than private demand.
3. Analyze the graph: Observe that the SD curve is above the PD curve at any given quantity. This suggests that the social value of the good is higher than the private value, indicating a positive externality.
4. Consider the implications: The presence of a positive externality means that the market equilibrium quantity (where PD intersects S) is less than the socially optimal quantity (where SD intersects S).
5. Conclude based on the analysis: Since the SD curve is consistently above the PD curve, the diagram represents a situation with a positive externality.