SOCIAL COST & BENEFITS
PRIVATE COST:
Definition of Private costs
A
cost incurred in the production process
by the producer or consumption process by the consumer. Private costs are paid only by the producer or
consumer concerned. They are internal costs of production or consumption.
Private cost for producer is cost of production & for consumer is price of
the goods / services.
PRIVATE COST = SOCIAL
COST – EXTERNAL COST
EXTERNAL COSTS
Definition of External costs
An external costs occurs when producing or consuming
a good or service imposes a cost upon a third party. If there are external
costs in consuming a good (negative externalities), the social cost will be
greater than the private cost.
The existence of external costs can lead to market
failure. This is because the free market generally ignores the existence of
external costs.
EXTERNAL COST =
SOCIAL COST – PRIVATE COST
Example of External Cost
Driving a car imposes a private cost on the driver
(cost of petrol, tax and buying car). However, driving a car creates costs to
other people in society.
These can include:
·
Greater congestion and slower journey times for other drivers.
·
Cause of death for pedestrians, cyclists and other road users.
·
Pollution, health related problems.
·
Noise pollution.
SOCIAL
COST
Definition of social cost –
Social cost is the total cost to society. It
includes both private costs plus any external costs.
The social costs of smoking include the passive
smoking that other people experience.
The social cost involved in building and running an
airport can be split up into:
Private costs of airport
·
Cost of constructing airport.
·
Cost of paying workers to run airport
External Cost of airport
·
Noise and air pollution to those living nearby.
·
Risk of accident to those living nearby.
·
Loss of landscape.
SOCIAL COST = EXTERNAL
COST + PRIVATE COST
Market
Failure
Market
failure occurs when freely-functioning markets, fail to deliver an efficient
allocation of resources. The result is a loss of economic and social welfare.
Market failure exists when the competitive outcome of markets is not efficient
from the point of view of society as a whole. This is usually because the
benefits that the free-market confers on individuals or businesses carrying out
a particular activity diverge from the benefits to society as a whole.
There are many instances when the
free market fails to deliver an efficient allocation of resources.
Market failure
results in
- Productive inefficiency:
Businesses are not maximising output from given factor inputs. This is a
problem because the lost output from inefficient production could have
been used to satisfy more wants and needs
Allocative inefficiency:
Resources are misallocated and producing goods and services not wanted by
consumers. This is a problem because resources can be put to a better use
making products that consumers value more highly
CAUSES OF MARKET FAILURE
Markets can fail because of:
- Negative externalities (e.g. the effects of
environmental pollution) causing the social cost of production to exceed
the private cost.
- Positive (or
beneficial) externalities
(e.g. the provision of education and health care) causing the social
benefit of consumption to exceed the private benefit
- Imperfect information means merit goods are
under-produced while demerit goods are over-produced or over-consumed
- The private
sector in a free-markets
cannot profitably supply to consumers pure public goods and quasi-public goods that
are needed to meet people’s needs and wants
- Market dominance by
monopolies
can lead to
under-production and higher prices than would exist under conditions of
competition
- Factor immobility causes unemployment hence
productive inefficiency
- Equity (fairness)
issues. Markets
can generate an ‘unacceptable’ distribution of income and consequent
social exclusion which the government may choose to change
HOW MARKET FAILURE CAN BE CONTROLLED?
Options
for government intervention in markets
There
are many ways in which intervention can take place – some examples are given
below
Government
Legislation and Regulation
Parliament
can pass laws that for example prohibit
the sale of cigarettes to children, or ban smoking in the workplace.
The
laws of competition
policy act against examples of price-fixing cartels or other
forms of anti-competitive behaviour by firms within markets.
Employment
laws may offer some legal protection for workers by setting
maximum working hours or by providing a price-floor in the labour market
through the setting of a minimum wage.
Regulation
may be used to introduce fresh
competition into a market – for example breaking up the
existing monopoly power of a service provider.
Fiscal
Policy Intervention
Fiscal
policy can be used to alter the level of demand for different products and also
the pattern of demand within the economy.
- Indirect taxes such as changes in VAT and excise
duties can be used to raise the price of demerit goods and products with
negative externalities designed to increase the opportunity cost of
consumption and thereby reduce consumer demand towards a socially optimal
level.
- Subsidies to consumers will lower the
price of merit goods such as grants to students to reduce the internal
costs of staying on in full-time education and subsidies to businesses
employing unemployed workers on the New Deal programme. They are designed to
boost consumption and output of products with positive externalities – a
subsidy causes an increase in market supply and leads to a lower
equilibrium price (see the separate revision focus article on producer
subsidies).
- Tax relief: The government may offer
financial assistance such as tax credits for business investment in
research and development. Or a reduction in corporation tax designed to
promote investment and employment.
- Changes to taxation
and welfare payments
can be used to influence the distribution of income and wealth – for
example higher direct taxes on rich households or an increase in the
value of welfare benefits for the poor to make the tax and benefit system
more progressive.
