In presence of a negative externality, the socially optimal quantity is where SMB equals MSC, and it is:

• A. Higher than the private equilibrium quantity.
• B. Lower than the private equilibrium quantity.
• C. Equal to the private equilibrium quantity.
• D. Not related to SMB and MSC.

Answer: (B)

With a negative externality, producing an extra unit imposes costs on others, so the social cost of production (MSC) is higher than the private cost. The socially optimal level is found where the social marginal benefit equals the social marginal cost (SMB = MSC). Because MSC includes the external cost, it lies above private marginal cost, so the intersection SMB = MSC occurs at a smaller quantity than the private equilibrium where private MB equals private MC. Therefore, the socially optimal quantity is lower than the private equilibrium quantity. This reflects why markets tend to overproduce when external costs are not internalized, and why policies aim to reduce output toward the social optimum.