Glossary – Negative Production Externality

Definition

The negative effects of economic activities that originate during the production process on unrelated third parties.

Example

The most common example of a negative production externality is the pollution caused by a firm during the production of their goods. Pollution affects the entire population, however as long as companies are not held accountable for their activities, they have no incentive to reduce their economic impact (since that would be more expensive).

Relevance

Without any regulatory influence, negative externalities will not be taken into account by the causers. This results in a market failure and an excess supply of harmful behavior, because the firms produce more than in an efficient market. Hence, regulations are needed to internalize externalities.

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