Economics · Oct / Nov 2016 · Paper 13 · Question 7

The use of cars in many cities creates negative externalities. The diagram shows the free market equilibrium X1 and the socially efficient market equilibrium X2. [diagram: axes labelled 'costs / benefits' (vertical) and 'quantity' (horizontal); demand curve D sloping downward; supply curves S1 and S2 sloping upward; S2 above S1; equilibrium X1 at intersection of D and S1 with price P1; equilibrium X2 at intersection of D and S2 with price P2] Using the diagram, which statement is correct?

1. ASocially efficient supply is S and the market price P is too high.
2. BSocially efficient supply is S and the market price P is too low.
3. CSocially efficient supply is S1 and the market price P is too high.
4. DSocially efficient supply is S1 and the market price P is too low.

As printed in the paper