Which of the following best describes a negative externality in terms of social costs and social benefits?

• A. A situation where the government subsidizes production to increase social benefits.
• B. A situation where the social cost exceeds the private cost due to harmful effects on third parties.
• C. A situation where the social benefit is less than the private benefit due to positive effects on third parties.
• D. A situation where the private cost equals the social cost, indicating no external effects.

Answer: (B)

Verified step by step guidance

1. Step 1: Understand the concept of externalities. Externalities occur when a third party is affected by the production or consumption of a good or service, without this effect being reflected in market prices.
2. Step 2: Define private cost and social cost. Private cost is the cost borne by the producer or consumer directly involved in the transaction, while social cost includes both the private cost and any external costs imposed on third parties.
3. Step 3: Recognize that a negative externality arises when the social cost exceeds the private cost. This means that the activity causes harmful effects on others that are not accounted for by the producer or consumer.
4. Step 4: Contrast this with social benefits and private benefits. A negative externality is about costs, not benefits, so the key is the difference between social and private costs, not benefits.
5. Step 5: Conclude that the best description of a negative externality is when the social cost is greater than the private cost due to harmful effects on third parties.