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

• A. A situation where the social benefit of an activity exceeds the private benefit.
• B. A situation where the social cost of an activity exceeds the private cost.
• C. A situation where the private cost of an activity exceeds the social cost.
• D. A situation where the private benefit of an activity exceeds the social benefit.

Answer: (B)

Verified step by step guidance

1. Understand the concept of externalities: Externalities occur when the actions of individuals or firms have effects on third parties that are not reflected in market prices.
2. Define private cost and social cost: Private cost is the cost borne by the producer or consumer directly involved in the activity, while social cost includes both the private cost and any external costs imposed on others.
3. Recognize that a negative externality arises when the activity imposes additional costs on society that are not accounted for by the private cost.
4. Express this relationship mathematically: A negative externality exists when social cost (SC) is greater than private cost (PC), i.e., \(\text{SC} > \text{PC}\).
5. Conclude that the correct description of a negative externality is 'a situation where the social cost of an activity exceeds the private cost,' because this means the activity causes harm or costs to others beyond what the decision-maker considers.