Negative externalities

A negative externality is a cost imposed on a 'third party' as a result of the activities or buyers or sellers.

Most transactions in market economies create externalities - some of which are beneficial - yet not paid for by the beneficiaries - and some have a detrimental effect on others, although they are not compensated by those causing the negative effect.

Negative consumption externalities

Negative externalities associated with consumption are any negative effect on third parties as a result of the acquisition and use of goods and services. An example of a commonly discussed external cost of consumption is the amount of waste plastic discarded after use. Discarded waste can cause harm to others in a variety of ways, including visual pollution, toxic waste, and the loss of the use of land.

Other costs of consumption include harm to others as a result of alcohol consumption, the impact of 'passive' cigarette smoking, and the carbon and other emissions resulting from travelling to and from stores and other venues, such as theatres and restaurants.

Diagrammatically, the impact of a negative consumption externality is to push the Marginal Social Benefit Curve down, below the Marginal Private Benefit curve.

In other words, at any level of output (Q) the 'actual' benefit to the community of consumption is reduced as a result of the consumption externality.

Negative externalities

Negative production externalities

Negative production externalities are any negative impact on a third party as a result of the process of production and distribution of goods and services.

Factories and offices use energy which is likely to have been derived from fossil fuels, which are a source of pollution. Many processes, such as cloth production, use chemicals which may find their way into rivers, and into the food chain.

Road congestion can also be considered a negative production externality. The rise of online shopping has increased road usage by haulage companies, which in turn increases congestion and lead to other harms, including air and noise pollution and lost time waiting in traffic.

Toxic waste explained - National Geographic

Graphically, external production externalities shift the Marginal Social Cost up, above the Marginal Private Cost curve.

In other words, at any level of output (Q) the 'actual' cost to the community from production is greater than the sum of the 'private' costs borne by firms.

Negative production externalities

In both cases, if left unregulated, negative consumption and production externalities would lead to an inefficient allocation of scarce resources.


  1. Goods that are polluting could be subject to taxation, which could help reduce production to a more socially efficient and sustainable level. Taxes will help 'internalise' the externality, so that decisions to produce or consume goods which generate negative externalities are less likely, or individuals and firms are encouraged to find alternative goods, or methods of production. As is often the case, the effectiveness of a tax depends on the consumer’s price elasticity of demand for the polluting product.
  2. Governments could ban production which emits carbon and other waste.
  3. Pollution permit schemes could be used, which encourage firms to reduce their emissions. [See more on carbon permits].

  4. Subsidies could be given to producers to encourage them to switch to greener technology.
  5. Government could allocate ownership rights to open spaces, including waterways and beaches so that polluters can be privately sued if they pollute.
  6. Public information programmes could be used to close information gaps affecting both consumers and producers.
  7. Special measures can be introduced to restrict traffic flows and reduce congestion, including 'park and ride' schemes, special travel lanes, increased parking charges, special 'congestion' charges, and subsidies to improve public transport.
  8. Small 'nudges' could be used to change behaviour - a policy favoured by those influenced by research from behavioral psychologists. Small nudges are arguably less 'blunt' a weapon than taxes and subsidies as they can be targeted very specifically to the consumers and producers generating the externality. For example, the use of signage to provide more information about the consequences of decisions, and setting 'default' choices in favour of less harmful options, such as making 'regular' fast-food options fat or salt free.

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