The real life example here is electric utilities. The way they're regulated they charge a kWh price roughly equal to the average total cost (let’s say about 12 cents). The proper way to price would be at the marginal cost (at around 4 cents). The fact that marginal costs are below average total costs are what makes them a natural monopoly.
The somewhat obvious better solution would be to charge marginal cost for each kWh and then have some other method to collect the massive fixed costs. But for whatever historic reasons, we don't do that and most (all?) utilities price each kWh at about the average total cost. This means that as a society our quantity demanded kWh is way below where economic theory says it should be.
However, there is probably a fairly substantial pollution/CO2 externality to producing electricity. Without some analysis it isn't obvious whether we're producing too much electricity or too little.
I did try once to look at estimates of the size of the externality to see if it made up for the pricing way above marginal cost issue and the preliminary results were that the externality was smaller (meaning, global warming considered, we're still not using enough electricity). However, there were a couple of points I'd need to get into deeper.
1) The pricing above marginal cost issue is greatest for residential rates and smallest for industrial rates. I was looking at residential rates. Using the same cursory analysis on industrial rates would mean that we're over using electricity in industrial sectors.
2) The carbon externality number I used from the EPA seemed to be derived by figuring out how high the price of electricity would need to be to get usage down to the level they wanted. Under correctly priced utility rates (i.e., priced at the marginal costs), their analysis may have had a much higher $ / kWh externality number. But at the same time, I’m a little suspect of that method of calculating the externality as it would indicate if the cost of production halved it wouldn’t be optimal for society to produce more. So I’d need to do some more research to make sure I’m using good pollution/CO2 numbers.
I haven't seen this issue discussed by people like Mankiw when they talk about the Pigou Club and I think it probably should be. If there's interest I could probably write this up a bit more formally and make it a post.
There exists much better work than that on power production externalities. ExternE, for starters. Which mostly prove that the amount of pollution has remarkably little to do with how much power you produce, and a heck of a lot to do with which technologies you use to produce them. Major takeaway if you do not care to read that "Coal is not a good idea, even ignoring the carbon.".
Example nicked from this online Berkeley lecture.
Monopolies are bad (morality and economics agree here).
Firms that pollute are bad (morality and economics agree here).
What about monopolies that pollute?
What about strong monopolies that pollute and receive government subsidies?
Well...
Pollution, and other negative externalities, cause firms to produce too much of their product. That's because they don't pay the full cost of the product, including the impact of pollution.
The equilibrium behaviour for monopolies is to produce too little of their product, to keep prices and profits high.
So a monopoly that pollutes is subject to two opposite tendencies: the unpriced-pollution tendency to produce too much, and the monopolistic tendency to produce too little. If the effects are of comparable magnitude, then the monopoly might be much closer to social optimum than a free market would be (the social optimum, incidentally, will generally involve some pollution: we need to accept some pollution in the production of fertiliser, for instance, in order to have enough food to stop people starving).
In fact, if the monopolistic effect is too strong, then the firm may under-produce, even taken the pollution effect into account. In that case, we can approach closer to the social optimum by... subsidising the polluting monopoly to produce more!!
And that, my friends, is why economics is not a morality tale.