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

• Market Failure
• Negative Externalities
• Positive Externalities
• Public Goods
• Merit and Demerit Goods
• Policies to Overcome Market Failure
• Tax on Negative Externality Diagram
• Subsidy on Positive Externality Diagram
• Market Failure at Tutor 2U
• Cost Benefit Analysis