Final answer:
When producers impose external costs, they often set the price of their goods lower and their output higher than what would be economically efficient. These prices do not reflect the full cost to society, which includes environmental and social costs. Properly accounting for these external costs would lead to a decrease in production and a shift of the supply curve to the left, achieving closer alignment with economic efficiency.
Step-by-step explanation:
When the actions of the producers of a good impose an external cost, the price of the good will be lower, and the output higher than would be consistent with economic efficiency.
External costs, such as social and environmental costs, are not reflected in the good's market price when only private costs are considered. When these external costs are taken into account, the true cost to society increases, which, in an economically efficient scenario, should decrease the quantity of the good produced and consumed. If a good’s price does not reflect its external costs, it can lead to overproduction and overconsumption, misallocating resources away from their best use, and resulting in a net loss of welfare for society.
For example, if firms ignore the environmental damage caused by their production, they may produce more than the allocatively efficient level, where P = MC (Price equals Marginal Cost). This results in excessive production, where the marginal cost to society outweighs the benefit, leading to inefficiencies.
Conversely, the inclusion of higher production costs due to accounting for externalities, typically causes a firm to supply a smaller quantity at any given price and shifts the supply curve to the left, aligning more closely with economic efficiency.