Question

Social costs are the sum of the internal costs and the external costs of an activity. If there is a negative externality from an activity, it means, by definition, that external costs exist. Adding these external costs to the internal costs of the activity results in social costs that are greater than the internal costs alone." How are social costs affected by negative externalities?

a) Social costs remain the same
b) Social costs decrease
c) Social costs become equal to internal costs
d) Social costs increase beyond internal costs

Answer 1

Social costs increase when negative externalities are present because they add external costs to the private costs incurred by the firm. This increase in social costs illustrates a market failure, where the true costs to society are not reflected in the market price.

Step-by-step explanation:

Social costs are affected by negative externalities in that they increase beyond the internal costs incurred by a firm. When a negative externality is present, such as pollution, it imposes extra costs on third parties who are not involved in the production or consumption of goods or services. These external costs add to the private costs to yield the true social costs, which are higher as a result of these negative externalities. For example, a factory might emit pollutants that harm the health of nearby residents, and the costs associated with this impact (such as healthcare costs and reduced quality of life) are not reflected in the price of the factory's product but are very real societal costs. This scenario is an example of market failure, where the market's supply curve does not represent all social costs and the firm does not have the incentive to reduce the externality because the market price does not capture the full cost to society.