SOCIAL COST = PRIVATE COST + EXTERNALITY
For example: - a chemical factory emits wastage as a by-product into nearby rivers and into the atmosphere. This creates negative externalities which impose higher social costs on other firms and consumers. e.g. clean up costs and health costs.
Another example of higher social costs comes from the problems caused by traffic congestion in towns, cities and on major roads and motor ways.
It is important to note though that the manufacture, purchase and use of private cars can also generate external benefits to society. This why cost-benefit analysis can be useful in measuring and putting some monetary value on both the social costs and benefits of production.
MARKET FAILURE AND EXTERNALITIES
When negative production externalities exist, marginal social cost > private marginal cost. This is shown in the diagram below where the marginal social cost of production exceeds the private costs faced only by the producer/supplier of the product. In our example a supplier of fertiliser to the agricultural industry creates some external costs to the environment arising from their production process.
This leads to the private optimum output being greater than the social optimum level of production. The producer creating the externality does not take the effects of externalities into their own calculations. We assume that producers are only concerned with their own self interest.
In the diagram above, the private optimum output is when where private marginal benefit = private marginal cost, giving an output of Q1. For society as a whole though the social optimum is where social marginal benefit = social marginal cost at output Q2.The failure to take into account the negative externality effects is an example of market failure.
- Pollution from cars and motorbikes
- Litter on streets and in public places
- Noise pollution from using car stereos or ghetto-blasters
- Negative externalities created by smoking and alcohol abuse
- Externalities created through the mis-treatment of animals
- Vandalism of public property
- Negative externalities arising from crime
In these situations the marginal social benefit of consumption will be less than the marginal private benefit of consumption. (i.e. SMB < PMB) This leads to the good or service being over-consumed relative to the social optimum. Without government intervention the good or service will be under-priced and the negative externalities will not be taken into account. Again there will be a deadweight loss of economic welfare.
In the example shown in the chart above we illustrate the potentially negative effects of prople consuming cigarettes on other consumers. The disutility (dis-satisfaction) created leads to a reduction in the overall social benefit of consumption. If the cigarette consumer only considers their own private costs and benefits, then there will be over-consumption of the product. Ideally, the socially efficient level of cigarette consumption will be lower (Q2). The issue is really which policies/strategies are most appropriate in reducing the total level of cigarette consumption!
