Which type of externality occurs when the social cost of an activity exceeds the private cost, leading to overproduction from a societal perspective?

• A. Positive externality
• B. Negative externality
• C. Public good
• D. Market equilibrium

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. Identify the difference between 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 when social cost exceeds private cost, it means there are additional negative effects on society not accounted for by the market participant.
4. Understand that this situation leads to overproduction from society's perspective because the market equilibrium is based only on private costs, ignoring the external costs.
5. Conclude that this type of externality is called a negative externality, as it imposes external costs and results in a higher quantity produced than is socially optimal.