Which of the following best measures the impact of a negative supply shock in the presence of externalities?

• A. The marginal benefit received by consumers
• B. The sum of consumer surplus and producer surplus
• C. The equilibrium price in a perfectly competitive market
• D. The difference between social cost and private cost

Answer: (D)

Verified step by step guidance

1. Step 1: Understand what a negative supply shock is — it is an event that reduces the supply of a good or service, shifting the supply curve to the left, which typically raises prices and reduces quantity.
2. Step 2: Recognize that externalities occur when the private cost or benefit of producing or consuming a good differs from the social cost or benefit, meaning the market outcome is not socially optimal.
3. Step 3: Identify that the private cost is the cost borne by producers, while the social cost includes both private cost and any external costs imposed on society (e.g., pollution).
4. Step 4: Realize that the impact of a negative supply shock with externalities is best measured by the difference between social cost and private cost, because this difference captures the external costs that are not reflected in the market price.
5. Step 5: Conclude that neither consumer surplus, producer surplus, nor equilibrium price alone fully capture the external effects, so the key measure is the gap between social and private costs.