In a situation in which internal costs differ from social costs, we say that there exists a(n)
A welfare loss.
B welfare benefit.
C internality.
D externality.
The correct answer and explanation is:
The correct answer is D externality.
An externality occurs when the costs or benefits of a market activity are not fully reflected in the prices paid by the individuals involved. These effects spill over to third parties who are not directly part of the transaction. If internal costs differ from social costs, it indicates that the private cost of production or consumption does not fully reflect the true cost to society. In this case, the difference between private costs and social costs leads to a market failure, and this is what we call an externality.
Externalities can be either negative or positive. Negative externalities occur when the social cost of a good or service exceeds the internal cost, meaning society bears some of the burden. A common example is pollution: a factory may not pay for the environmental damage it causes, which means the community suffers from poor air quality, higher health costs, and environmental degradation. On the other hand, positive externalities happen when the social benefit exceeds the private benefit, such as when a person’s education benefits not just themselves but also society by contributing to economic growth, lower crime rates, and higher productivity.
The presence of an externality means that the market is not allocating resources efficiently. In the case of negative externalities, markets tend to overproduce goods, while in the case of positive externalities, they underproduce goods. Government intervention, such as taxes, subsidies, or regulation, is often required to correct the inefficiency caused by externalities and bring the market closer to a socially optimal outcome.