Question 10.1

1. The nature of the external cost imposed

   The external cost is the pollution caused by the wastewater runoff, an uncompensated cost imposed by the poultry farms on their neighbors.

2. The outcome in the absence of government intervention or a private deal

   Since poultry farmers do not take the external cost of their actions into account when making decisions about how much wastewater to generate, they will create more runoff than is socially optimal in the absence of government intervention or a private deal. They will produce runoff up to the point at which the marginal social benefit of an additional unit of runoff is zero; however, their neighbors experience a high, positive level of marginal social cost of runoff from this output level. So the quantity of wastewater runoff is inefficient: reducing runoff by one unit would reduce total social benefit by less than it would reduce total social cost.

3. The socially optimal outcome

   At the socially optimal quantity of wastewater runoff, the marginal social benefit is equal to the marginal social cost. This quantity is lower than the quantity of wastewater runoff that would be created in the absence of government intervention or a private deal.