How does a negative externality affect market equilibrium?

How does a negative externality affect market equilibrium?

• A. The social cost is lower than private cost.
• B. The social benefit exceeds private benefit.
• C. The market produces the socially optimal quantity.
• D. The social cost exceeds private cost, causing the market to overproduce.

Answer: (D)

A negative externality means the cost to society of producing a unit is higher than the cost borne by the producer. The social cost includes both private costs and the external costs imposed on others, so the social cost curve lies above the private cost (supply) curve. Because producers ignore the external costs, they produce where price equals private cost, which is a quantity higher than the socially optimal level. The result is overproduction. The other statements misstate the idea: social cost is not lower than private cost, and benefits aren’t the issue here. The market isn’t producing the socially optimal quantity in the presence of a negative externality. The correct takeaway is that social cost exceeds private cost, leading to overproduction.

A negative externality means the cost to society of producing a unit is higher than the cost borne by the producer. The social cost includes both private costs and the external costs imposed on others, so the social cost curve lies above the private cost (supply) curve. Because producers ignore the external costs, they produce where price equals private cost, which is a quantity higher than the socially optimal level. The result is overproduction.

The other statements misstate the idea: social cost is not lower than private cost, and benefits aren’t the issue here. The market isn’t producing the socially optimal quantity in the presence of a negative externality. The correct takeaway is that social cost exceeds private cost, leading to overproduction.