Editing Externality (section)

===External costs===
[[File:Negative externality.svg|384px|right|thumb|Demand curve with external costs; if social costs are not accounted for price is too low to cover all costs and hence quantity produced is unnecessarily high (because the producers of the good and their customers are essentially underpaying the total, real [[factors of production]]).]]
The graph shows the effects of a negative externality. For example, the [[steel industry]] is assumed to be selling in a competitive market – before pollution-control laws were imposed and enforced (e.g. under [[laissez-faire]]). The marginal private cost is less than the marginal social or public cost by the amount of the external cost, i.e., the cost of [[air pollution]] and [[water pollution]]. This is represented by the vertical distance between the two supply curves. It is assumed that there are no external benefits, so that social benefit ''equals'' individual benefit.

If the consumers only take into account their own private cost, they will end up at price '''P<sub>p</sub>''' and quantity '''Q<sub>p</sub>''', instead of the more efficient price '''P<sub>s</sub>''' and quantity '''Q<sub>s</sub>'''. These latter reflect the idea that the marginal social benefit should equal the marginal social cost, that is that production should be increased ''only'' as long as the marginal social benefit exceeds the marginal social cost. The result is that a [[free market]] is ''[[inefficiency|inefficient]]'' since at the quantity '''Q<sub>p</sub>''', the social benefit is less than the social cost, so society as a whole would be better off if the goods between '''Q<sub>p</sub>''' and '''Q<sub>s</sub>''' had not been produced. The problem is that people are buying and consuming ''too much'' steel.

This discussion implies that negative externalities (such as pollution) are ''more than'' merely an ethical problem. The problem is one of the disjunctures between marginal private and social costs that are not solved by the free market. It is a problem of societal communication and coordination to balance costs and benefits. This also implies that pollution is not something solved by competitive markets. Some ''collective'' solution is needed, such as a court system to allow parties affected by the pollution to be compensated, government intervention banning or discouraging pollution, or economic incentives such as [[green tax]]es.