How do negative externalities reflect a divergence between private and social costs?

Negative externalities reflect a divergence between private and social costs as they represent the additional costs borne by society, not accounted for by private individuals or firms.

Negative externalities occur when the production or consumption of a good or service imposes a cost upon a third party, which is not considered in the private cost. The private cost is the cost that the producer or consumer of a good or service directly incurs. However, the social cost includes both the private cost and the cost to society. Therefore, when negative externalities are present, the social cost of production or consumption is higher than the private cost.

For instance, consider a factory that produces goods but also emits pollution as a by-product. The private cost of production might include the cost of raw materials, labour, and other direct expenses. However, the pollution created by the factory imposes additional costs on society, such as healthcare costs for those affected by the pollution, or environmental clean-up costs. These are the negative externalities. They are not borne by the factory but are instead imposed on society. Therefore, the social cost of production (private cost plus the cost of the negative externality) is higher than the private cost alone.

This divergence between private and social costs can lead to market failure. This is because the presence of negative externalities means that the market price does not reflect the true cost of production or consumption. As a result, goods or services may be overproduced or overconsumed from a societal perspective, leading to a loss of social welfare.

In conclusion, negative externalities reflect a divergence between private and social costs by representing the additional costs to society that are not considered in the private costs. This divergence can lead to market failure as the market price does not accurately reflect the true cost of production or consumption.