Which statement is always true about a negative externality?

Which statement is always true about a negative externality?

• A. It results in a market output that is greater than the socially optimal output
• B. It has no impact on the socially optimal output
• C. It shifts supply to the right, increasing efficiency
• D. It causes the market quantity to be exactly equal to social optimum

Answer: (A)

A negative externality occurs when the production or consumption of a good imposes costs on others that are not reflected in the market price. Because buyers and sellers ignore those external costs, the private cost they consider is lower than the true social cost. This makes the market quantity too high relative to what would maximize social welfare, so the market output ends up greater than the socially optimal quantity. That’s why the statement describing market output as being higher than the socially optimal level is always true. Graphically, the social cost curve sits above the private cost curve. The quantity where demand meets private cost is to the right of the quantity where demand meets the social cost, creating the overproduction. The other descriptions don’t fit: the externality does affect the socially optimal output, it doesn’t shift the private supply to increase efficiency, and the market quantity is not forced to equal the social optimum.

A negative externality occurs when the production or consumption of a good imposes costs on others that are not reflected in the market price. Because buyers and sellers ignore those external costs, the private cost they consider is lower than the true social cost. This makes the market quantity too high relative to what would maximize social welfare, so the market output ends up greater than the socially optimal quantity. That’s why the statement describing market output as being higher than the socially optimal level is always true.

Graphically, the social cost curve sits above the private cost curve. The quantity where demand meets private cost is to the right of the quantity where demand meets the social cost, creating the overproduction. The other descriptions don’t fit: the externality does affect the socially optimal output, it doesn’t shift the private supply to increase efficiency, and the market quantity is not forced to equal the social optimum.