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The existence of external benefit and external cost leads to misallocation of resources. External cost For example, when drivers are not liable for the health damage of car exhaust, drivers will equate only marginal private cost with marginal benefit. But if drivers are forced to pay for the health damage of car exhaust, their marginal cost will go up by the amount of the external cost.
Negative and positive externalities. In the case of pollutionâthe traditional example of a negative externality âa polluter makes decisions based only on the direct cost of and profit opportunity from production and does not consider the indirect costs to those harmed by the pollution.here are differences between private returns or costs and the costs or returns to society as a whole. Smoking is bad for you (photo: Radius Images/Corbis). Consumption, production, and investment decisions of individuals, households, and firms often affect people not directly involved in the transactions.