Registered Environmental Manager (REM) Practice Exam

What describes a negative externality?

1. Positive impacts of production known to all stakeholders

2. Disadvantages affecting third parties without compensation

3. Market-driven adjustments that improve public welfare

4. Benefits shared equally among producers and consumers

The correct answer is: Disadvantages affecting third parties without compensation

A negative externality is characterized by disadvantages or costs that affect third parties who are not directly involved in a transaction or economic activity, and these parties do not receive compensation for the impacts they experience. This concept is critical in environmental management as it highlights situations where an economic activity imposes additional costs on society that are not reflected in the market price. For instance, a factory that pollutes a nearby river may lower production costs while imposing health issues and clean-up costs on the community, which has no direct role in the factory’s operations. The other choices focus on different concepts that do not accurately describe negative externalities. Positive impacts of production known to all stakeholders refer to beneficial externalities, where benefits are shared or recognized. Market-driven adjustments that improve public welfare suggest a situation where the market operates effectively to resolve issues, which is not necessarily the case with negative externalities. Lastly, benefits shared equally among producers and consumers do not account for the imposition of costs on third parties, thereby failing to capture the essence of a negative externality.