What best defines a negative externality?

What best defines a negative externality?

• A. Cost imposed on third parties not reflected in market price; example: pollution from a factory harming nearby residents.
• B. Benefit enjoyed by producers that is not paid for by consumers.
• C. Cost borne by the producer that is fully reflected in the market price.
• D. Non-excludable public good.

Answer: (A)

A negative externality occurs when the action of one party imposes costs on others that are not reflected in the market price. Pollution from a factory harming nearby residents is a classic example: the factory’s production creates harm that buyers of its product don’t pay for, so the market price underestimates the true social cost. Because those external costs are not priced, the market tends to overproduce from society’s perspective, causing welfare loss unless policy tools like taxes or regulations force the external costs to be internalized. The other descriptions don’t fit this idea: a private benefit to producers is not an external cost to others, costs fully reflected in price imply no externality, and a non-excludable public good is a different concept altogether.

A negative externality occurs when the action of one party imposes costs on others that are not reflected in the market price. Pollution from a factory harming nearby residents is a classic example: the factory’s production creates harm that buyers of its product don’t pay for, so the market price underestimates the true social cost. Because those external costs are not priced, the market tends to overproduce from society’s perspective, causing welfare loss unless policy tools like taxes or regulations force the external costs to be internalized. The other descriptions don’t fit this idea: a private benefit to producers is not an external cost to others, costs fully reflected in price imply no externality, and a non-excludable public good is a different concept altogether.