7.4.4—Externalities in consumption/production

A negative production externality makes MSC exceed MPC, while a negative consumption externality makes MSB fall below MPB. Positive externalities reverse the relevant gap.

Label the private and social curves first, then compare the market intersection with the social intersection where MSB = MSC. The diagram shows the direction of misallocation; it does not by itself choose the best policy.

If education creates benefits for classmates, MSB lies above MPB and the market consumes too little. If a chemical factory pollutes a river, MSC lies above MPC and the market produces too much.

Do not shift both curves automatically: production spillovers change cost, consumption spillovers change benefit, and some activities can contain both.