Social costs and benefits
Private costs and benefits
Private sector firms
Aim
to maximize their profits
Private costs = wages, rents, components,
insurance premiums, telephone bills, electricity,
etc.
Private benefits = revenue from the sale of
products to consumers
Consumers
Aim
to maximize their utility (or satisfaction)
Private costs = payments for goods
and services
Private benefits = satisfaction from consuming
the products they buy
Market failure
Some producers and consumers may ignore the harmful
effects of their production and consumption decisions and
activities on other consumers, firms and the environment
because they are only concerned with their own private costs
and benefits
External costs
Social costs
Total social cost = private costs + external costs
External benefits
Social benefits
Total social benefit = private benefits + external benefits
An economic use of resources?
If total social benefit > total social cost
Economic welfare can be improved by encouraging
more production and consumption
If total social cost > total social benefit
Economic welfare can be improved by reducing
production and consumption
Correcting market failure
How can a government in a mixed economy ensure that firms and consumers take
account of the external costs and benefits of their decisions and actions?
India to enforce new regulations to
curb noise pollution
The Australian government has banned live
cattle exports to Indonesia until safeguards are
adopted to end the brutal slaughter of animals
TheChinesegovernmentannounces
18recyclingprojectsaretoreceive
governmentsubsidiescoveringupto
50%oftotalinvestmentcosts
Government unveils plan to tax the
carbon emissions of the worst
polluters
Tax on landfill to increase by 20% as the
government attempts to reduce the amount of
waste that ends up in the ground.
South Africa bans plastic bags to
reduce litter
Retailers caught handing out the bags now
face a fine of 100,000 rand ($13,800) or a 10year jail sentence
Correcting market failures
To reduce external costs
•
•
Raise taxes on firms with activities that
create external costs to reduce those
firms’ after-tax profits, e.g. taxes on
To increase external benefits
•
emissions from the use of fossil fuels, on
landfill waste and mineral extraction
education, public parks, public transport and
roads
•
Increase indirect taxes on products that
are considered harmful to raise their
prices and discourage their consumption,
Provide subsidies to private sector firms
to reduce the cost of activities and
products that have external benefits, e.g.
e.g. taxes on cigarettes, petrol, plastic bags
•
Ensure public sector provision of socially
and economically desirable goods and
services, e.g. providing free vaccinations and
Use regulations and fines to discourage
the production or consumption of
products or activities that are harmful,
e.g. smoking bans, planning controls, legal
limits on air and water pollutants, anti-litter laws
•
subsidies for recycling, renewable energy,
organic farming
Use regulations to encourage firms to
change their production methods, e.g.
rules to phase out traditional light bulbs to
encourage a switch to low-energy light bulbs,
health and safety regulations, animal welfare
laws
What are the costs & benefits of
opening a new airport?
Private costs
•
•
•
Building costs – e.g. cost of materials,
cost of planning permission
Running costs – e.g. heating, lighting
Labour costs – e.g. employing builders
and staff to run the airport
External costs
•
•
•
Private benefits
•
•
•
Increased Profits – e.g. people using
the airport once it is finished
Higher profile – e.g. company is more
likely to win similar contracts in the
future
Increase value of company – e.g. share
price will rise if it is a company
Environmental Concerns – e.g. more
road traffic and noise pollution
Loss of trade at other airports – e.g.
they will have fewer customers
Decreased values of nearby property –
e.g. local homeowners would see the
value of their homes fall
External benefits
•
•
•
More jobs – e.g. local people have better
choice of jobs
More foreign visitors – e.g. these people
will spend money in other local
businesses (such as hotels)
Cheaper airfares – e.g. airport will be
keen to attract customers, so will give
airlines favorable rates to get them to
use the airport
What are the costs & benefits of
opening a sports shop?
Private costs
External costs
• labor costs – wages, salaries,
national insurance, pension funds
• Material costs – sportswear
• Overheads – heating, lighting,
business rates, building and
contents insurance
• If the new sports shop is freshly
built then there may be some
noise during building, traffic holdups, fumes, dirt etc.
Private benefits
External benefits
• Profits/sales revenue
• Increase in share value (if a
company)
• Job security for employees
• Provision of high quality
sportswear may encourage people
to get fit…benefiting society
• Creation of employment
• Earned income is taxed. These
taxes are then used by the
government to build hospitals (for
example)