What is it: The social costs (social costs) is a private costs plus external costs. Personal costs are borne by individuals who are directly involved in economic activities or transactions. Meanwhile, external costs are borne by third parties who are not directly involved in the transaction.
Social costs are the opposite of social benefits , which represent the benefits that businesses and households receive from their production or consumption activities. It is the same as private benefits plus external benefits.
Components of social costs
In neoclassical economics, social costs consist of:
- Private costs ( private costs )
- External costs ( external costs )
The total social cost is equal to the sum of the two. If we write it down mathematically, the social cost formula is as follows:
Social costs = Personal costs + External costs
Under a perfectly competitive market, output would be socially efficient if it consisted only of private costs. There are no external costs.
Private costs represent costs borne by economic actors, which influence their economic decisions. Neoclassical economics assumes no government intervention. Thus, economic actors only consist of businesses and households (consumers), where the main economic activities and decisions are about production and consumption.
In production, personal costs include costs for the production of goods or services. This includes the costs the company incurs to purchase capital equipment, hire labor, and purchase materials or other inputs.
Thus, private costs influence the decision to produce goods and services by the business sector. In addition, these costs also form the selling price of the product, in addition to the percentage of profit (markup) they charge.
For consumption, personal costs represent the price that consumers pay for goods and services. When you buy flu medicine, you pay a fee, which is the price of the flu medicine.
External costs are not reflected in the company’s production costs. You won’t see it on the company’s income statement . Likewise, it is also not reflected in the prices that consumers pay. However, external costs remain costs to society, regardless of who pays them.
For example, a textile company may seek to save money. They then did not install any water pollution control equipment or factory effluents. Because of the company’s actions, cities located downstream of the river have to pay for the negative effects of waste or pollution. River water becomes unfit for drinking. To meet their drinking needs, they have to buy clean water.
In short, external costs represent costs that arise as a result of negative externalities. Economic actors who are not directly involved in economic activities must bear the impact. In the above case, they are the community around the river. They may not work in a textile company. However, due to water pollution, they have to spend money to buy clean water, which is not from the company. Other examples of external costs are noise, congestion, and visual disturbances.
Ideally, external costs should be added to private costs to determine social costs. It is essential to produce a socially efficient level of output.
Social cost effect
Under a competitive market, market output will be efficient if production (supply) and consumption (demand) decisions take social costs into account. Market prices represent not only production costs but also external costs, which are not borne by the transacting party. In addition, social costs also have an impact on market output, competition and resource use.
Say, the external costs associated with production (eg the impact of waste) are significant. Companies do not pay for it, for example through taxes or by buying waste processing machines. In this case, the selling price of the goods is lower than it should be because external costs are not taken into account.
At that level of production, output may be efficient for the firm. However, it is not socially efficient. Consumers of the product may benefit from low prices. However, other communities, who do not consume, must bear the costs due to waste.
Without government intervention, littering would probably become a common practice for businesses. This practice saves money because there is no need to treat waste.
That is one of the most common reasons why governments should intervene. The government then formulates policies to improve externalities. Without government intervention, businesses will pursue their own profits by ignoring the negative externalities of their production activities. It also applies to negative externalities due to consumption of goods.
However, questions and problems then arise, how to quantify these social costs? The impact on environmental, socio-economic or political damage is difficult to measure, especially in the long term. In addition, the negative external impact not only affects the domestic market but also the international market. A good example is the impact of carbon emissions on global warming.