Q e

1. P Q Recall that the price a consumer is prepared to pay reflects the marginal utility at that quantity of consumption. Consider the market-determined equilibrium quantity Qe: If there are 3rd party benefits leaking out from the transaction to others, that means that the price understates the MU gained at that quantity - i.e. the price for that quantity would be higher if the benefits were contained and had to be paid for. This is equivalent to the true DD really being at D1D1. Third party benefits have caused DD to be understated leading to less Q being bought and sold at a lower P than people are actually willing to pay. D1 D S Pe D1 S D Q1 Qe 3rd Party Benefits

2. P Q Also recall that the price at which a producer is prepared to sell reflects the production costs (marginal cost, actually) for that quantity of consumption. Consider the market-determined equilibrium quantity Qe: If there are 3rd party costs leaking out from the transaction to others, that means that the price understates the production costs at that quantity - i.e. the price for that quantity would be higher if the costs were contained and had to be paid for in the sale of the product. This is equivalent to the true SS really being at S1S1. Third party costs have caused SS to be overstated leading to more Q being bought and sold at a lower P than the actual marginal cost of production. S1 D S Pe S1 S D Q1 Qe 3rd Party Costs