A negative externality in production typically leads to

• A. Deadweight loss due to overproduction
• B. Deadweight gain due to underproduction
• C. No deadweight loss
• D. Social optimum at market equilibrium

Answer: (A)

A negative externality in production means costs imposed on others are not reflected in the production cost faced by the firm. Because producers don’t pay the full social cost, they produce more than what would be socially optimal. The social marginal cost is higher than the private marginal cost, so the market quantity exceeds the efficient quantity. The result is a deadweight loss—the welfare lost from overproducing beyond the socially optimal level.

This isn’t a deadweight gain, which would come from underproduction and a misalignment where society benefits from producing less. It isn’t no deadweight loss, because the external cost creates inefficiency. It isn’t the social optimum at market equilibrium, because the market equilibrium is based on private costs, not the higher social costs caused by the externality.