Which statement correctly describes the impact of negative externalities in a competitive market?

In a competitive market, negative externalities occur when a third party is negatively affected by the actions of individuals or firms that are not accounted for in the market transactions. This situation leads to a divergence between private costs—the costs incurred by the individual or firm producing the good—and social costs, which include both the private costs and the external costs imposed on third parties.

When external costs are present, the private costs faced by producers are lower than the actual costs to society. As a result, producers have less incentive to reduce production, leading to overproduction of goods that create negative externalities. This misalignment causes market failures, as the market price does not reflect the true cost of the good being produced.

Thus, the correct statement highlights the critical issue of how negative externalities distort the market by creating a difference between private costs and social costs. Understanding this relationship is fundamental in economics, particularly in discussions about the need for government intervention to correct market failures and align private incentives with social welfare.