If a company’s production leads to significant pollution, the marginal social cost of its product is equal to the marginal private cost plus the external cost of pollution. Therefore, without government intervention, the market will naturally produce at the socially optimal level of output.

When a company produces goods but also creates pollution, it affects not just its own costs but also the wider community. The marginal private cost is what the company pays to make its product, while the external cost refers to the harm caused by pollution, like health issues or environmental damage. Without government intervention, the company may not consider these external costs, leading to overproduction and more pollution than is socially acceptable. For example, if a factory produces steel and pollutes the air, the cost to society from that pollution is not included in the factory's production costs. Therefore, the market will not reach a socially optimal level of output on its own because it fails to account for the true cost of production, which includes both private and external costs.