Social Costs & Social Benefits (Cambridge International A-Level Economics)

Understanding social costs

• In many markets, the costs of producing or consuming a good are not limited to the buyer and seller

• Some costs are imposed on third parties, meaning people who are not directly involved in the transaction

• These are known as 'external costs'.

  • When external costs exist, the true cost to society is higher than the private cost faced by firms and consumers

Key definitions

• Marginal private cost (MPC)

  • The additional cost incurred to the consumer and producer through the consumption or production (output) of one additional unit of output

• Marginal external cost (MPE)

  • The additional cost incurred to a third party through the consumption or production (output) of one additional unit of output

• Marginal social cost (MSC)

  • The additional cost incurred to society incurred through the consumption or production of one additional unit of output
  • It is the sum of the private costs plus the external costs

Case Study Air Pollution From Coal Power

Context

• Coal-fired power stations are widely used in countries such as China, India, and South Africa to generate electricity
• Electricity producers sell power to households and firms at a price that mainly reflects their private production costs

External Cost

• Burning coal releases air pollutants and greenhouse gases

• These cause:

  • Respiratory illnesses
  • Environmental damage
  • Increased healthcare costs

• These costs are borne by society rather than the electricity producers

Implication for efficiency

• The marginal social cost (MSC) of producing electricity is higher than the marginal private cost (MPC)
• Firms only consider their private costs when deciding output
• As a result, the market produces more electricity from coal than is socially optimal
• This creates allocative inefficiency and welfare loss

Exam Hint You must not confuse social costs with external costs

Social Costs = Private Costs + External Costs

Understanding social benefits

• Some goods create benefits that extend beyond the individual consumer
• These benefits affect third parties who are not directly involved in the transaction These are known as external benefits
• When external benefits exist, the true benefit to society is greater than the private benefit received by consumers
• This means the market may produce too little output, leading to allocative inefficiency

Key definitions

• Marginal private benefit (MPB)

  • The additional benefit received by the consumer and producer from the consumption or production (output) of one additional unit of output

• Marginal external benefit (MEB)

  • The additional benefit incurred by a third party through the consumption or production (output) of one additional unit of output

• Marginal social benefit (MSB)

  • The benefit to society received from the consumption or production (output) of one additional unit of output
  • It is the sum of the private benefits plus the external benefits

Case Study Markets and external benefits

The image below shows markets which offer external benefits

• Governments and international organisations such as the World Health Organization (WHO) promote vaccination programmes worldwide
• Individuals receive vaccines to protect themselves from diseases such as measles or COVID-19

External Benefit

• Vaccinated individuals are less likely to spread infectious diseases

• This protects:

  • vulnerable groups
  • unvaccinated individuals
  • the wider community

• Society therefore gains additional health benefits beyond the individual consumer

Implication for efficiency

• The marginal social benefit (MSB) of vaccination is greater than the marginal private benefit (MPB)
• Individuals may underestimate the wider benefits to society
• As a result, the free market may lead to under-consumption of vaccines
• This creates allocative inefficiency, as society would benefit from higher vaccination rates

Exam Hint You must not confuse social benefits with external benefits

Social Benefits = Private Benefits + External Benefits