What is the difference between an external cost and an external benefit?
An external cost is a cost of a transaction that must be paid by some party not in the transaction. An external benefit is similar, but it is a benefit from a transaction that is received by some party not involved in a transaction. 2. Why are markets with externalities inefficient? Markets with externalities can either produce too much or too little. When there is an external cost, the marginal private cost is below the marginal social cost; thus, the firm produces more than is socially optimal. When there is an external benefit, the marginal private benefit is below the marginal social benefit, and thus, the firm produces too little. For efficiency, the MC of society must equal the MR. 3. What is the difference between using taxes to solve an externality problem and using the Coase theorem? When taxes are used to solve an externality problem, the government must directly assess the marginal damage cost and impose it on the firm. The Coase solution is to assign a clear right to the fi
