What is a negative externality in the context of market efficiency?

A negative externality occurs when a person's or a company's actions have harmful effects on others who are not directly involved in the activity. For example, if a factory releases pollution into the air, the nearby community suffers from poor air quality, even though they are not part of the factory's operations. This situation leads to market inefficiency because the factory does not have to pay for the damage it causes, so it may produce more than what is socially ideal. When the costs of these negative effects are not included in the price of the product, it can lead to overproduction and a loss of overall welfare for society. Addressing negative externalities often requires government intervention, such as regulations or taxes, to help align private costs with social costs.