Final answer:
Negative externalities occur when the production of a good imposes costs on third parties that are not reflected in the market price. In the context of steel production, firms may dump waste to avoid disposal costs, thus creating external costs for society. This represents a market failure that often necessitates government intervention to correct.
Step-by-step explanation:
A negative externality is a cost suffered by a third party as a result of an economic transaction. In a market, when a company produces a good, they incur private costs which are reflected in the supply curve (Sprivate). However, if they are creating pollution as they produce, they are also creating an external cost that the society has to pay for, like health issues and cleaning costs which is not reflected in the supply curve, leading to what is known as a negative externality.
For simplicity, let's consider the market for steel. If steel firms are dumping industrial waste into local waterways, they are imposing external costs on society (e.g., harming marine life, affecting water quality for other uses), which are not included in their private costs. In a standard supply and demand diagram for the market of steel, the market price and quantity are determined at the intersection of the demand curve (D) and the private supply curve (Sprivate). This results in a market equilibrium (Eo) that does not account for the pollution being dumped into waterways.
The motivation for firms to pollute the local waterways is often economic; by avoiding the costs associated with proper waste disposal, they lower their private costs of production and can supply at a lower price, gaining a competitive edge or higher profits. This represents a market failure where the market equilibrium quantity of steel produced and the price do not reflect the true social costs of production. Government intervention, such as taxes, regulations, or tradable permits, is usually necessary to address this market failure and internalize the external costs.