In the presence of a negative externality in production, which statement about market quantity is correct?

• A. The market quantity is equal to socially optimal
• B. The market quantity is greater than socially optimal
• C. The market quantity is not determinable
• D. The market quantity is less than socially optimal

Answer: (B)

A negative externality in production means the costs of making the good spill over to others (like pollution). Firms ignore these external costs and produce where their private marginal cost meets the private benefit, not where the total social cost meets the benefit. The socially optimal quantity, by contrast, is found where marginal social cost equals marginal benefit (private cost plus the external cost). Since external costs aren’t counted by the market, the private marginal cost is lower than the true social cost at any given quantity, so the market produces too much. Therefore, the market quantity is greater than the socially optimal quantity.