Negative Production - Pollution Example

Negative Production Externality Diagram

MSC > MPC

In this example, pollution is used as an example of a negative production externality. Pollution has a negative effect when it is produced, therefore it is a negative production externality. The social cost of producing pollution is higher than the private cost (MSC > MPC), therefore firms overproduce, producing the amount that is good for them, and not at the level which is good for society. The MSC curve is to the left of the MPC curve since that is like the supply curve, but is more costly than the MPC curve, therefore it is to the left.

When there is a negative production externality, we want to reduce production in order to maximise social welfare. (This makes sense, as less pollution is good). However no pollution would not be truly best for society because this would mean having to shut down lots of power stations, and leave many without power, and then likely there would be shortages of water and food.

The filled in area represents the welfare loss because of the market failure.

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