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Please credit: John D. MacArthur Foundation. Meet more Fellows focused on Economics Michael Woodford. Social costs will differ from private costs, for example, if a producer can avoid the cost of air pollution control equipment allowing the firm's production to imposes costs health or environmental degradation on other parties that are adversely affected by the air pollution. Remember too, it is not just producers that may impose external costs on society.

Let's also view how consumers' actions also may have external costs using Field's previous example on driving: 2. The social costs include all these private costs fuel, oil, maintenance, insurance, depreciation, and operator's driving time and also the cost experienced by people other than the operator who are exposed to the congestion and air pollution resulting from the use of the car.

Social Economics Market Behavior in a Social Environment

The key point is that even if a firm or individual avoids paying for the external costs arising from their actions, the costs to society as a whole congestion, pollution, environmental clean up, visual degradation, wildlife impacts, etc. Those external costs must be included in the social costs to ensure that society operates at a socially efficient rate of output. Aside from the obvious environmental issues, one might ask why external costs are of interest to economists? Resource Implications A socially efficient output rate in a competitive market is reached when social costs both private and external costs are considered in production and consumption decisions.

The existence of external costs has implications for product prices, output levels, resource usage, and competition. When significant external costs are associated with a good or service , then the price of the good is too low because external costs are not being paid and its output level is too high, relative to the socially efficient rate of output for the good. The bottom line, unless costs and prices include external costs, the market will not produce a socially efficient result.

The Socioeconomic Factors Affecting Small Businesses |

Consider also the competitive issues: At the individual firm level, as well as across states or nations, failure to pay for external costs would provide those firms or nations with a competitive advantage over producers who are paying the external costs associated with the production of their products.

If you're interested, a graphic examination of the issue follows! Here's the Graphic Illustration for those who like charts! In the graphic illustration, the intersection of the demand curve and marginal cost curve represents the socially efficient rate of output in a competitive market. However, in the case where external costs exist, we need to plot two curves: The marginal private cost curve and the marginal social cost curve equals the marginal private cost curve plus the marginal external cost curve.

Comparing prices and outputs illustrates how external costs affect resource allocation.