Which of the following best describes the marginal external cost and the socially optimal quantity in the presence of a negative externality?

• A. Marginal external cost is the difference between marginal private cost and marginal private benefit; the socially optimal quantity occurs where marginal social benefit equals marginal private cost.
• B. Marginal external cost is the sum of marginal private cost and marginal social benefit; the socially optimal quantity occurs where marginal private cost equals marginal social cost.
• C. Marginal external cost is the difference between marginal social cost and marginal private cost; the socially optimal quantity occurs where marginal social benefit equals marginal social cost.
• D. Marginal external cost is the difference between marginal private benefit and marginal social benefit; the socially optimal quantity occurs where marginal private cost equals marginal private benefit.

Answer: (C)

Verified step by step guidance

1. Understand the concept of a negative externality: it occurs when the production or consumption of a good imposes a cost on third parties that is not reflected in the market price.
2. Define Marginal Private Cost (MPC) as the cost borne by the producer for producing one more unit, and Marginal Social Cost (MSC) as the total cost to society, including both MPC and the external cost.
3. Recognize that Marginal External Cost (MEC) is the difference between Marginal Social Cost and Marginal Private Cost, expressed as: \(\text{MEC} = \text{MSC} - \text{MPC}\).
4. Identify that the socially optimal quantity is where Marginal Social Benefit (MSB) equals Marginal Social Cost (MSC), ensuring that the external costs are accounted for in the decision-making process.
5. Conclude that the correct description involves MEC as the difference between MSC and MPC, and the socially optimal quantity occurs where MSB equals MSC.