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Private and Social Costs


Externalities create a divergence between the private and social costs of production.

Social cost includes all the costs of production of the output of a particular good or service. We include the third party (external) costs arising, for example, from pollution of the atmosphere.




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.



E-mail Steve Margetts