Negative Production

Externality
Unit 5 - Lesson 3
Learning Outcomes
● Define all terms in orange bold in section 5.3. (AO1)
● Explain negative production externality and the resulting welfare loss. (AO2)
● Draw a diagram illustrating negative production externality and welfare loss.
(AO4)
● Calculate the welfare loss that results from a negative production externality.
(AO4)
● Explain that negative production externalities can be used to illustrate
overuse of common pool resources. (AO2)
Explain negative production externality and the resulting welfare loss.
(AO2)

Negative Production Externality

● Free market over allocates resources to the

production of the good. Too much of the good is
being produced relative to what society desires.
● The Quantity produced by the free market is
greater than the Quantity desired by society.
● At the Quantity produced by the free market the
MSC (additional cost to society for the production
of an additional unit of output) is greater than the
MSB (additional benefit society receives from
consuming one more unit of output).
Explain negative production externality and the resulting welfare loss.
(AO2)
Negative Production Externality cont.

● The over allocation of resources to the

production of the good results in additional
costs/spillover costs to society that are not
accounted during the private transaction.
○ From the picture to the right the additional
cost are:
■ Pollution resulting in depletion of the
ozone, reduced air quality and acid
rain
● Society breathing polluted air
resulting in increased illness.
Draw a diagram illustrating negative production externality and welfare
loss. (AO4)
The diagram to the right represents a
Negative Production Externality.

A Negative Production Externality

arises when the production of a good
results in additional/spillover cost to a
3rd party or society.

An example of a Negative Production

Externality - Factory that uses fossil
fuels in the production of their goods.
Draw a diagram illustrating negative production externality and welfare
loss. (AO4)

How to use the graph to explain a

Negative Production Externality - be
sure to follow along on the graph.

● The free market is at equilibrium at

point A where the MPB (the
additional benefit the consumer
receives from consuming an
additional unit of a good) is equal to
MPC (additional cost to the producer
for producing an additional unit of
output) at (Pfm - Qfm).
Draw a diagram illustrating negative production externality and
welfare loss. (AO4)
● Society desires Point C where the
MSB (additional benefit to society) is
equal to MSC (additional cost to
society) at (P-so, Q-so).
● Point C is the allocative efficient
quantity of output - Qso.
● At Qfm, MSC (point B) is greater
than MSB (point A) therefore the
market is not allocatively efficient.
● There is an over allocation of
resources to the production of the
good - (Qfm is greater than Qso)
Draw a diagram illustrating negative production externality and
welfare loss. (AO4)
● The vertical distance between MSC
(point B) and MSB (point A)
represents the external or
additional/spillover costs incurred
by society from the private
transaction.
● Triangle A, B, C represents the Total
Welfare Loss (TWL) to society.
○ TWL is the loss of social
benefits due to the
overproduction of the good
caused by the externality.
Draw a diagram illustrating negative production externality and
welfare loss. (AO4)

A Negative Production Externality

is a market failure because of the
additional/spillover costs incurred
by society from the production of
the good. There is an over
allocation of resources to the
production of the good.
Calculate the welfare loss that results from a negative production
externality. (AO4)

To calculate the Total Welfare Loss

(TWL) find the area of Triangle A, B, C.

Area of a Triangle =

(height (B - A)) X width (Qfm - Qso))

divided by 2
Explain that negative production externalities can be used to illustrate
overuse of common pool resources. (AO2)
To illustrate the depletion on Common
Pool Resources we can use the
Negative Production Externality
diagram.

The vertical distance between the MSC

and MPC - external/spillover cost to
society - such as global warming,
depletion of tuna stocks in the ocean or
depletion/degradation of any other
common pool resource