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

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

Answer: (D)

Verified step by step guidance

1. Step 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. Step 2: Differentiate between private and social costs and benefits. Private costs and benefits are borne directly by the decision-maker, while social costs and benefits include both private effects and external effects on others.
3. Step 3: Define a negative externality. It arises when the social cost of an activity is greater than the private cost, meaning the activity imposes additional costs on society that the decision-maker does not pay for.
4. Step 4: Analyze the options given. The correct description of a negative externality is when the social cost exceeds the private cost, indicating that the activity causes harm or costs to others beyond the private cost incurred.
5. Step 5: Conclude that the best description of a negative externality is: 'A situation where the social cost of an activity exceeds the private cost.'