Suppose Figure 2 represents the market for good X.

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.