Gasoline brings great benefit to those who buy it, but burning it also creates external costs. Consider the graph below, which shows the demand for gasoline, the private marginal cost of producing gasoline, and the social marginal cost of producing gasoline.
Price ($/gallon) Quantity of gasoline

a. Suppose that buyers and producers of gasoline do not consider the external marginal costs they impose on others. Determine the equilibrium quantity and price; then use the letters in the diagram to fill in the appropriate spaces in the table below:

b. Suppose that conscientious sellers, out of the sheer goodness of their hearts, decide to incorporate external marginal costs into their production decisions. Determine the new quantity and price, then use the letters in the diagram to fill in the appropriate spaces in the table above.
c. Producers rarely do something out of the goodness of their hearts, and are likely to consider only their private marginal costs. Compare total surplus in both cases to determine the deadweight loss of the externality when external marginal costs are not considered.

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Price (S/gallon) SMC1 MC P2 P1 CE 2 Q1 Quantity of gasoline External Marginal Costs External Marginal Not Considered Costs Considered Consumer Surplus Producer Surplus External Damage (-) Total net value to society