Assume that the firms in an industry pollute a river. if there is no government intervention, the firms will produce more output than is socially efficient.
This is known as negative externality.
When it is talked about the pollution, the traditional example of a negative externality which is given is a polluter making decisions based only on the direct cost of the production and the profit opportunity arising from production.
He does not consider the indirect costs incurred by him or the people to those harmed by the pollution.
The indirect costs generally includes decreased quality of life, higher health care costs as well as the forgone production opportunities.
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