In the context of externality graphs, which of the following scenarios best illustrates the need for government intervention to correct welfare loss due to a negative externality affecting third parties?

A negative externality occurs when an activity causes harm to people who are not involved in that activity, leading to a situation where the overall welfare of society decreases. For example, consider a factory that produces goods but also releases pollution into the air. The factory’s owners benefit from their profits, but the nearby residents suffer from health problems and lower quality of life due to the pollution. In this case, the government may need to step in by imposing regulations or taxes on the factory to reduce pollution, which helps to correct the welfare loss experienced by the affected community. By taking action, the government can ensure that the factory considers the well-being of others, leading to a more balanced and fair outcome for society.