What Are Negative Externalities?

MRU explains negative externalities with a real-world example: overuse of antibiotics leading to the evolution of “superbugs.” Antibiotic users benefit from the drugs, while society at large bears the added cost (and risk) of increased antibiotic resistance leading to hard-to-treat infections.

A few highlights from the video:

The Definition of Negative Externalities. Externalities occur when a transaction between two parties also affects third parties (bystanders). A negative externality occurs when the transaction imposes costs on bystanders. Air and water pollution are classic examples of negative externalities.

Graphing Negative Externalities. We can plot negative externalities on a supply and demand graph, using a new line for social costs (above the supply curve by the amount of the external cost). The social cost curve intersects the demand curve at the socially optimal quantity.

The Impact of Negative Externalities. The market overproduces a good with a negative externality relative to the efficient equilibrium. Society is worse off due to the oversupply, resulting in deadweight loss. At the efficient equilibrium, where the social cost curve intersects the demand curve, social surplus—the sum of producer surplus, consumer surplus, and bystander surplus—is maximized.

Be sure to check out our other videos covering positive externalities, as well as public policy solutions to address externalities: Pigouvian taxes and subsidies, Coasean bargaining, tradable allowances, and command and control.

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00:00 Penicillin & superbugs
01:12 Market for antibiotics - consumers & producers
02:05 Introducing bystanders & externalities
02:52 How antibiotic use causes superbugs
03:50 Graphing a negative externality
06:03 Value of the last unit the market produces
07:04 Low value uses
08:12 Summary