Negative Externalities:
- Negative externalities occur when the consumption or production of a good causes a harmful effect to a third party.
- For Example, if you play loud music at night your neighbour may not be able to sleep.
- If you produce chemicals, but cause pollution, then local fishermen will not be able to catch fish. This loss of income will be the negative externality.
- Therefore with a negative externality Social Cost > Private Cost
Diagram of Negative Externality
with Deadweight welfare loss
- In a free Market people ignore the external costs to others therefore output will be at Q1 (where Demand = Supply).
- This is socially inefficient because at Q1 Social Cost > Social Benefit.
- Social Efficiency occurs at Q2 where Social Cost = Social Benefit
The red triangle is the area of dead weight welfare loss. It indicates the area of overconsumption (where MSC is greater than MPC)
See also: Economics of Congestion for Example
Essays and Revision Notes on Market Failure
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