In the presence of a negative externality, social costs typically exceed private costs.

• A. Social costs equal private costs
• B. Social costs exceed private costs
• C. Private costs exceed social costs
• D. There are no costs to society

Answer: (B)

When a negative externality is present, the activity creates costs for others that the producer does not pay. The social cost is private cost plus the external cost. Since the external cost is positive, social costs exceed private costs. For example, a factory might pay for its inputs and labor, but the pollution it releases imposes health and environmental costs on nearby residents that the factory doesn’t cover. Those added costs are part of social costs, so total social costs are higher.

If there were no externalities, social and private costs would be the same. It wouldn’t make sense for private costs to exceed social costs in this context, and there are indeed costs to society whenever a negative externality exists.