Part IV. Internalities In class we introduced the possibility that internalities and exter- nalities could interact. One consequence is that it might modify the Pigouvian prescription in that the optimal tax rate is not simply equal to marginal damages. But, we noted that if the internality is heterogeneous, this will lead to a Diamond- like second-best situation. We explore this graphically here. Below is a depiction of a market with an internality with two types of agents, la- beled "Market for Energy Efficient Good." In this market, some buyers are fully rational (no internality) and some who are myopic (have an internality that causes them to undervalue the good). Both types of agents have the same true marginal benefits equal to the line labeled true MB. But, the myopic agents misperceive their benefits and demand too little of the good. Their MB curve is shifted down vertically by $9. The good is sold in a competitive market with constant marginal cost of production equal to $22. But, there is also a constant positive externality per unit produced equal to $12. The corresponding social marginal cost curve is drawn. Assume that there are an equal number of myopic and rational agents so that each MB curve represents same 4