Negative externalities are costs caused by an activity that affect an otherwise uninvolved party who did not choose to incur that cost.
The reason these negative externalities, otherwise known as social costs, occur is that these expenses are generally not included in calculating the costs of production. Government intervention is necessary to help "price" negative externalities. They do this through regulations or by instituting market-based policies such as taxes, subsidies, or permit systems. Graphically, social costs will be lower than private costs because they do not take into account the additional costs of negative externalities. As a result, firms may produce more units than is optimal from a societal standpoint. Graphically, social costs will be lower than private costs because they do not take into account the additional costs of negative externalities. As a result, firms may produce more units than is optimal from a societal standpoint.
