Question

When it comes to economics would you please explain in 300 words the difference between the private and social costs?

Answer 1

Ans) Private cost is the cost borne by an individual entity that it pays while being engaged in production activity. It includes all direct cost like cost of factors of production involved in the process. Like for example, it includes cost of labour in form of wages, capital, investment cost, rent etc.

Before going to social cost, first let us understand the external cost. External cost are not directly attached to the production activity, rather it is attached indirectly. External cost need not always be negative, they are positive as well. For eg- pollution caused by firm, education, taking public vehicle instead of private which reduces congestion, etc are an example of external cost, which is not directly included in the production activity.

Social cost = Private cost + External cost. So, social cost refers to the cost of producing a commodity to the society as whole. It includes all the cost directly and indirectly borne by the society. This cost is not borne by the firms, rather it is borne by those who are not directly involved in the production activity. Eg- water pollution caused by firms, noise pollution caused by factories and traffic , education, apiculture which not only produces honey but also helps in plant pollination etc.

When a firm produces a good, it calculates its fixed cost and variable costs involved in production and then sets the price of the good but it does not count the external cost caused by it which though not directly but is indirectly attached with the production.

It is important to understand the difference between the two concepts as when we do not add external costs in the production, it leads to market failure because the equilibrium price which is established in market is flawed and do not count the cost of damages or benefits indirectly caused by it.