Final answer:
An efficient solution to the externality problem between Wong and David includes a payment from David to Wong for not playing music. The negative externality in the trumpet playing scenario is the noise disturbance as a social cost, and accounting for this externality would typically result in a higher equilibrium price and lower quantity compared to when just private costs are accounted for.
Step-by-step explanation:
The given question considers the externality problem between Wong and David, where Wong values playing loud music and David values peace and quiet. Since Wong has the right to play loud music and there are no transaction costs, an efficient solution involves David paying Wong not to play music.
Provided David values quiet more than Wong values loud music, David would be willing to pay up to $100 for peace, and Wong would accept any amount over $50. Consequently, any amount between $50 and $100 would be an efficient transfer payment from David to Wong.
In the context of the negative externality discussion, where a firm is playing trumpets in the streets, the negative externality is the social cost to others who are not involved in the transaction, typically being noise disturbances.
When only private costs are considered (Qs₁), the equilibrium price and quantity are reached without considering the social costs. However, when the social costs are factored in (Qs₂), the supply curve shifts, generally increasing the equilibrium price and lowering the equilibrium quantity, reflecting the true cost of the activity including the externality.