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CA Foundation · Business Economics · Public Finance

A chemical factory in an industrial town discharges effluents into a river, harming the fishing income of villagers downstream. The factory does not pay for this harm. In economic terms, which type of market failure is this?

This is a negative externality in production. The factory's effluents impose costs on downstream villagers who are not part of the transaction, and these costs are not included in the factory's private costs. Social cost therefore exceeds private cost, and the market overproduces the good.

  1. ANegative externality in productionCorrect
  2. BPositive externality in consumption
  3. CInformation asymmetry
  4. DNatural monopoly

Explanation

The factory imposes a cost on third parties (the villagers) that is not reflected in its private costs. This is a negative externality of production, so the social cost exceeds the private cost. A positive externality would involve unpaid benefits to third parties, which is not the case here.

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