Question

True-False-Ambiguous and Explain why 7. The equilibrium price of coal is $50 per ton. Coal generates a negative externality of $20 per ton, but then the negative externality increases to $40 per ton. Therefore, consumer surplus will increase and the deadweight loss will grow. Draw a graph.

Answer 1

The statement that increase in negative externality will raise consumer surplus and lead to increase in deadweight loss is False. In reality when the negative externality increases consumer surplus declines and deadweight loss increases.

In the diagram the consumer surplus when negative externality was $20 per ton and MSC is taken into consideration is given by the area of the triangle ABC. The deadweight loss is given by the triangle CDE. The MSC is marginal social cost curve that takes into account negative externality and MC is marginal private cost.

Now, it is given that the negative externality increases to $40 per ton. This will shift the MSC curve upward from MSC1 to MSC2. However, the MC curve will remain unchanged. Now, the deadweight loss is given by the area of the triangle FDG and consumer surplus is given by the area of the triangle AHF. We can see that while the consumer surplus has by the area HBCF, deadweight loss has increased by the area FCEG.

MSc, Me eadweight los A MSC2 Consumer Surphies MSCI H E MC C B Quantity