With a negative externality, market equilibrium quantity Qm is typically what relative to the social optimum Q*?

• A. Qm < Q*
• B. Qm = Q*
• C. Qm is unpredictable
• D. Qm > Q*

Answer: (D)

Negative externalities cause the market to overproduce relative to what’s socially optimal. When a production activity imposes costs on others (like pollution) that the producer doesn’t pay, the private cost used to determine output is too low. The true social cost of each additional unit is higher than the cost the firm bears, so the market quantity is where private marginal cost equals marginal benefit, but the socially efficient quantity is where social marginal cost equals marginal benefit. Since social marginal cost lies above private marginal cost, that intersection happens at a smaller output than the market would choose. Therefore the market quantity, Qm, is greater than the social optimum, Q*. This overproduction creates a deadweight loss. Policies that internalize the externality, such as taxes or regulation, can raise the price faced by producers and move output closer to Q*.