a) Suppose the production of good X results in a negative externality. Redraw Figure 2. Add
the Marginal Social Cost curve on the diagram and label it MSC. Clearly label the market
equilibrium quantity and the socially optimal quantity on the diagram. Explain what is the
market failure in this case. Clearly label on the diagram the Pigouvian tax rate required to
correct the market failure.
b) Briefly describe two activities that lead to negative externalities and two activities that
lead to positive externalities.
Fig: 1