Why Do Negative Externalities Cause Overproduction?

Why Do Negative Externalities Cause Overproduction?

1 Answer

  1. Negative externalities can cause indusries to overproduce if these firms are not generating socially efficient output. Let’s say if an industry is spoiling the air quality or water quality for its production and not internalizing the cost of it then the marginal cost of production will be lower then the marginal social cost which would lead the firm to produce extra units of its good. If this cost is included to determine the output by the common economic equation of MR= MC then MC would be higher and with increase in cost the profit would reduce if produced more than efficient output, which will restrain it from overproducing.

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