Marginal Private Benefit
Marginal social benefit is illustrated in the graph above to show that it is equal to marginal external benefit plus marginal private benefit i.e.:
MSB = MEB + MPB
You can see this on the left-side of the graph, but you need to realize that private marginal benefits are simply the marginal revenue for the firm i.e. the price that it receives for each unit of output. So, the MSB curve is higher than the MEB curve because price is added to it.
Optimal Marginal Social Benefit & DWL Costs
You can see from the right-side of the graph that there is a red deadweight loss (DWL) area that represents the costs to society associated with the free-market price and output levels P and Q. These costs exist because there are social benefits from the product over and above the industry demand curve (which only reflects demand from buyers, rather than both buyers and third party beneficiaries).
The optimal price and output levels are determined by the intersection of the industry supply curve and the MSB curve. This occurs at a price of P* and Q* as shown.
Note, however, that this presents a problem. With an increased output of Q* each individual firm will need to increase its output from q to q*, but at this increased rate of production the firms will have to lower their prices to P' in order to attract enough buyers. You can see this from the industry demand curve, where Q* can only be sold at a price to buyers of P'.
To solve this problem the government will need to take action. This action will usually take the form of a Pigouvian subsidy for each unit of output that the firms sell. That subsidy will need to be large enough to fill the gap between P* and P' in order to encourage firms to produce at the desired output rate of q*.
If this is done successfully, then the industry will get rid of the deadweight loss economic costs and marginal social benefit will be optimized.
Economics & Demand Management
My regular readers will know that I generally take a negative view of government interventions in the economy, and that I much prefer to allow the forces of supply and demand to work out the best value outcomes. However, that sentiment generally applies to the demand-management policies that are commonly used to influence the business-cycle.
When it comes to the permanent market failures associated with externalities, I do support interventions to improve social outcomes. The simple graphs and illustrations presented here are, however, very difficult to reproduce in the real world.
This means that, while in principle there is scope here to improve upon free-market outcomes, a great deal of care needs to be taken to avoid mistakes. The costs of evaluating real-world imperfections in free market economics, and then monitoring how they evolve over time, are often prohibitively expensive.