Externalities and social costs and benefits
| English | Chinese | Pinyin |
|---|---|---|
| marginal social cost | 边际社会成本 | biān jì shè huì chéng běn |
| marginal private cost | 边际私人成本 | biān jì sī rén chéng běn |
| marginal social benefit | 边际社会收益 | biān jì shè huì shōu yì |
| social optimum | 社会最优 | shè huì zuì yōu |
| deadweight welfare loss | 无谓损失 | wú wèi sǔn shī |
| tradable pollution permits | 可交易污染许可 | kě jiāo yì wū rǎn xǔ kě |
The full cost of a decision
- A factory's price covers its wages and materials — but not the asthma its smoke causes downwind. Society pays that hidden bill.
- Weighing all the costs and benefits — social, not just private — is how economists judge whether a market produces the right amount.
Marginal social cost (MSC) equals marginal private cost plus the:
MSC = MPC + external cost imposed on third parties.
The social optimum is where:
Society is best off where marginal social cost equals marginal social benefit.
Marginal social benefit = marginal private benefit + the external ______.
MSB = MPB + external benefit.
Social cost and benefit
- Marginal social cost 边际社会成本 (MSC) = marginal private cost 边际私人成本 + the external cost.
- Marginal social benefit 边际社会收益 (MSB) = marginal private benefit + the external benefit.
- The social optimum 社会最优 is where MSC = MSB.
Externalities shift the social curve
A negative externality means the social cost is above the private supply curve; the free-market quantity is then too high.
The gap between the market outcome and the social optimum creates a deadweight welfare loss.
Over- or under-production relative to the optimum wastes welfare.
Welfare loss
- A free market produces where private cost = private benefit — usually not the social optimum.
- The gap creates a deadweight welfare loss 无谓损失 (the shaded triangle).
With a negative externality the market over-produces; the welfare-loss triangle measures the cost to society.
Match each externality to a correcting policy.
Tax/permits curb over-production; subsidies boost under-provided goods.
Correcting it
- Negative externalities: taxes, regulation, tradable pollution permits 可交易污染许可.
- Positive externalities: subsidies, free provision, information campaigns.
Private optimum ≠ social optimum. The market clears where private marginal cost = private marginal benefit. Add the externality and the social optimum is at a different quantity — that gap is the failure.
You've got it
- MSC = MPC + external cost; MSB = MPB + external benefit
- the social optimum is MSC = MSB; the market misses it → deadweight welfare loss
- correct with taxes/permits (negative) or subsidies (positive)