Negative Externalities:

Figure below  shows the effects of a negative externality. For example, the  steel industry is assumed  to  be selling  in  a competitive market -  before pollution-control laws were imposed and enforced.  The marginal private cost is  less than  the marginal social or public cost by  the  amount of  the external cost,  i.e.,  the cost  of the  smoking stacks  and  water pollution.  This  is represented  by  the  vertical  distance  between  the two  supply curves. It  is  assumed that there  are  no external  benefits,  so  that  social  benefit  equals individual benefit.

Supply and Demand with external costs:

If the consumers take  into account their own private cost only, they will end up  at price P, and quantity Q, instead  of  the more efficient price P,  and quantity  a.  The latter price and quantity reflect  the idea  that  the marginal social benefit should equal the marginal social cost, i.e.,  production should be increased only  as  long  as  the marginal social benefit exceeds the marginal social cost. The result  in  an  unfettered  market  is  ineficient  since  at  the quantity Q,  the social benefit  is  less than  the  societal cost,  so  society as a whole  would  be better off if the goods  between  Q and  a had not been produced. The problem is  that people are buying and consuming  too much.

This discussion implies that pollution  is a problem where  the  disjuncture between marginal and social costs that is not solved by the free market.