In the presence of a negative externality, how do marginal private cost and marginal social cost relate, and what misallocation condition is typical?

• A. MPC is the social cost; MSC is private; misallocation occurs when MB > MSC
• B. MPC is the cost borne by the producer; MSC includes external costs; misallocation occurs when MSC > MB; taxes can internalize
• C. MPC and MSC are always equal; no misallocation
• D. MPC is the consumer’s cost; MSC excludes externalities

Answer: (B)

When a negative externality is present, the private cost to the producer (MPC) is lower than the total cost to society. The social cost (MSC) adds the external damages imposed on others. Because those external costs aren’t reflected in the market price, production tends to exceed the socially optimal level. The typical misallocation is that MSC exceeds the marginal benefit (MB) at the current output, meaning the extra unit imposes more cost on society than the benefit it provides. The efficient point is where MB equals MSC. A tax can raise the private cost to match the social cost, internalizing the externality and moving production toward the socially optimal level.