Social Costs and Benefits

Private costs

• Private cost is the cost to the producer ie. The hire of machinery, buying of materials, payment of wages etc.

Private benefit

• This is the benefit earned by the producer from the process of production. [Revenue earned by the firms from its sales]

External costs• An external costs occurs when producing or consuming a good or service

imposes a cost upon a third party.• Example: • Driving a car imposes a private cost on the driver (cost of petrol, tax and

buying car). However, driving a car creates costs to other people in society.

• These can include:• Greater congestion and slower journey times for other drivers.

• Cause of death for pedestrians, cyclists and other road users.

• Pollution, health related problems.

• Noise pollution.

External benefit

• An external benefit occurs when producing or consuming a good causes a benefit to a third party.

• Cycling to work helps to reduce the level of pollution and congestion. Therefore other road users have quicker journey times and helps to reduce the level of pollution.

• A bee keeper produces honey, but as an external benefit, his bees help to fertilise nearby fruit trees.

Social cost

• Social cost is defined as a sum of the private cost and external costs.

• Social cost=private cost + external cost• The social cost is generally not borne by an

individual.• It may be borne by entire society, city or even

country. • It is very difficult to calculate due to the

inclusion of external costs.

Social benefit

• The increase in the welfare of a society that is derived from a particular course of action.

• The total benefits of an economic activity to both the individual and the spillover effects to third parties.

• Social benefits are the total of private benefits and any external benefits.

• Social benefit = private benefit + external benefit

Market failure

• Market failure occurs whenever markets fail to deliver an efficient allocation of resources and the result is a loss of economic and social welfare.

• Market failure exists when the competitive outcome of markets is not satisfactory from the point of view of society.

Causes of market failure

Government intervention in correcting market failure

• Taxation• Subsidies• Nationalization• Laws and regulations• Govt. policy and conflicts of interest

Government intervention

• Taxation:• To reduce the external cost, the government

can impose tax on those firms creating too much of external cost.

• Ex: green taxes

Government intervention

• Subsidies:• Private firms contributing to the external

benefits should be supported by the government by granting subsidies to them.

• These subsidies will encourage them to produce more.

• Ex: Public transport

Government intervention

• Nationalization:• Industries producing large external benefits

will be taken over by the government.• This will ensure the continued supply of

these services to the people.• Ex: railway

Government intervention

• Laws and regulations:• A government may introduce laws and

regulations in order to control firms creating external costs.

• Ex: Anti pollution laws.

Government intervention

• Taxes, subsidies, laws and regulations can also be used not just to influence the production decision, but also the decisions of consumers.

• Ex: taxes on cigarettes, free/subsidized vaccination etc.