Final answer:
The social cost of production with a negative externality includes private and external costs, like pollution, that affect third parties. This leads to market failure, with the product being overproduced and underpriced, as the market price does not reflect the full social costs.
Step-by-step explanation:
If a production process created a negative externality, then the social cost of production would include both the private costs incurred by the producing firm and the external costs, like pollution, that are suffered by third parties. Pollution is a classic example of a negative externality in production, as it imposes additional costs on society that are not reflected in the market price of the product. This disconnect between private costs and social costs leads to market failure, where the market equilibrium does not account for the full social costs, thus, resulting in overproduction and underpricing of the goods in question.
Products or services that come with negative externalities, such as pollution, tend to be produced in greater quantities and sold at lower prices than what would be socially optimal because the market fails to internalize the external costs into the product’s price. This results in excess production, which is not only inefficient but also detrimental to society’s welfare, as the social costs of production exceed the benefits to consumers.