Social cost in neoclassical economics is the sum of the private costs resulting from a transaction and the costs imposed on the consumers as a consequence of being exposed to the transaction for which they are not compensated or charged. In other words, it is the sum of private and external costs. This might be applied to any number of economic problems: for example, social cost of carbon has been explored to better understand the costs of carbon emissions for proposed economic solutions such as a carbon tax. Private costs refer to direct costs to the producer for producing the good or service. Social cost includes these private costs and the additional costs (or external costs) associated with the production of the good which are not accounted for by the free market. In short, when the consequences of an action cannot be taken by the initiator, we will have external costs in the society. We will have private costs when initiator can take responsibility for agent's action.
Definitions Mathematically, social marginal cost is the sum of private marginal cost and the external costs. For example, when selling a glass of lemonade at a lemonade stand, the private costs involved in this transaction are the costs of the lemons and the sugar and the water that are ingredients to the lemonade, the opportunity cost of the labor to combine them into lemonade, as well as any transaction costs, such as walking to the stand. An example of marginal damages associated with social costs of driving includes wear and tear, congestion, and the decreased quality of life due to drunks driving or impatience, and many people displaced from their homes and localities due to construction work. Another social cost of driving includes the pollution driving costs to other people in the society. For both private costs and external costs, the agents involved are assumed to be optimizing.
Alternatives The alternative to the above neoclassical definition is provided by the heterodox economics theory of social costs by K. William Kapp. Social costs are here defined as the socialized portion of the total costs of production, i.e., the costs which businesses shift to society in their attempts to increase their profits. In this sense Kapp's understanding of social costs is consistent with the "Social Costs of Carbon" calculations below because these costs arise primarily from carbon-based production (not exchange) and are shifted to society. Different from "social cost of carbon arguments" the cause of social costs is identified in existing capitalist accounting laws which allow producers to leave them unpaid. Due to its mode of economic calculation and accounting capitalism is essentially a system of cost shifting. Legalized cost shifting is one of the main sources of profits.
Economic theory According to the International Monetary Fund, "there are differences between private costs and the costs to the society as a whole". In a situation where there are positive social costs, it means that the first of the Fundamental theorems of welfare economics failed in that relying merely on private markets for price and quantity lead to an inefficient outcome. Market failures or situations in which consumption, investment, and production decisions made by individuals or firms result in indirect costs i.e. have an effect on parties external to the transaction are one of the most common reasons for government intervention. In economics, these indirect costs which lead to inefficiencies in the market and result in a difference between the private costs and the social costs are called externalities. Thus, social costs are the costs pertaining to the transaction costs to the society as a whole. Generally, social costs are easier to think about in marginal terms i.e. marginal social cost. Marginal social cost refers to the total costs that the society pays for the production of an extra unit of the good or service in question. Mathematically, this can be represented by Marginal Social Cost (MSC) = Marginal Private Cost (MPC) + Marginal External Costs (MEC). Social costs can be of two types—Negative Production Externality and Positive Production Externality. Negative Production Externality refers to a situation in which marginal damages are social costs to society that result in Marginal Social Cost being greater than the Marginal Private Cost i.e. MSC > MPC. Intuitively, this refers to a situation in which the production of the firm reduces the well-being of the people in the society who are not compensated for the same. For example, steel production results in a negative externality because of the marginal damages pertaining to pollution and negative environmental effects. Steelmaking results in indirect costs as a result of emission of pollutants, lower air quality, etc. For example, these indirect costs might include the health of a homeowner near the production unit and higher healthcare costs which have not been factored into the free market price and quantity. Given that the producer does not bear the burden of these costs, they are not passed down to the end user thus creating a situation where MSC > MPC.
… excerpt ends here. Continue reading the full article.
