Production externalities and marginal social cost
| English | 中文 | Pinyin |
|---|---|---|
| marginal social cost/ˈmɑːdʒɪnl ˈsəʊʃl kɒst/ | 边际社会成本 | biān jì shè huì chéng běn |
| marginal external cost/ˈmɑːdʒɪnl ekˈstɜːnl kɒst/ | 边际外部成本 | biān jì wài bù chéng běn |
A decision you can investigate
- A dye producer pays for labour and chemicals, but nearby households bear untreated effluent damage.
- A payment to the producer is not the same thing as the total cost of producing the dye.
Build the explanation
- Private cost falls on the decision-maker; external cost falls on third parties outside the compensated transaction. Social cost is private plus external cost. Marginal values refer to one extra unit; a total-cost figure cannot simply be drawn as a marginal gap. For a negative production externality, MSC lies above MPC, while MSB=MPB if consumption has no external effect.
- A positive production externality, such as uncompensated knowledge spillovers to other firms, makes net marginal social cost 边际社会成本 lower than private cost in this cost-side representation. State the mechanism before choosing which curve separates. A fall in a competitor’s revenue caused merely by a price change is not automatically an uncompensated resource externality.
Work through the evidence
- Take MPB=MSB=100−Q, MPC=20+Q and marginal external cost 边际外部成本 MEC=20. Hence MSC=MPC+MEC=40+Q. Private output solves 100−Q=20+Q, so Qm=40; social output solves 100−Q=40+Q, so Q*=30.
- At Qm, MSC=80 and MSB=60: the vertical gap is 20. Between 30 and 40 the lost net gain is a triangle: loss=½ × (40−30) × 20=100 currency units. It is not total damage, which is MEC × Qm=800 in this constant-damage case. For an alternative positive spillover of 20 per unit, MSC=MPC−20=Q. The social optimum would be 100−Q=Q, Q*=50: the unregulated private output of 40 is too low.
What is social marginal cost at output 40?
MSC=40+Q, so 80.
What is modeled welfare loss from excess output?
½ × 10 × 20 = 100.
Total external damage and the welfare loss from excessive output are the same area.
The loss compares marginal net gains for the inefficient units, not all external damage.
Test the limits
- The numerical marginal harm is assumed constant. Actual environmental damage may depend on location, thresholds and cumulative emissions. Transport has both production and consumption effects; congestion from driving can be treated as an external consumption cost when the choice model is journeys.
- Financial-system risk can impose costs on firms and households outside a lending transaction, but a bank’s own unpaid loss is a private cost. Avoid counting the same effect twice on both MSC and MSB. Measuring external damage and enforcing a corrective policy remain separate tasks.
With the alternative positive production spillover, why is private output too low?
The unpriced spillover lowers net social cost relative to private cost.
Apply and explain your answer
- Explain why the diagram’s welfare-loss triangle is 100 rather than 800.
- The triangle measures the net loss from output above the optimum; 800 is all modeled external damage at market output, including units whose benefits still justify social costs.
Match the terms to their meanings.
Use each term for its stated economic relationship.
Use the terms precisely
- marginal external cost: Uncompensated third-party cost from one additional unit.
- marginal social cost: Marginal private cost plus marginal external cost, net of any external production benefit.
Take MPB=MSB=100−Q, MPC=20+Q and marginal external cost MEC=20. Hence MSC=MPC+MEC=40+Q. Private output solves 100−Q=20+Q, so Qm=40; social output solves 100−Q=40+Q, so Q*=30. At Qm, MSC=80 and MSB=60: the vertical gap is 20. Between 30 and 40 the lost net gain is a triangle: loss=½ × (40−30) × 20=100 currency units. It is not total damage, which is MEC × Qm=800 in this constant-damage case. For an alternative positive spillover of 20 per unit, MSC=MPC−20=Q. The social optimum would be 100−Q=Q, Q*=50: the unregulated private output of 40 is too low.
The numerical marginal harm is assumed constant. Actual environmental damage may depend on location, thresholds and cumulative emissions. Transport has both production and consumption effects; congestion from driving can be treated as an external consumption cost when the choice model is journeys. Financial-system risk can impose costs on firms and households outside a lending transaction, but a bank’s own unpaid loss is a private cost. Avoid counting the same effect twice on both MSC and MSB. Measuring external damage and enforcing a corrective policy remain separate tasks.
Private cost falls on the decision-maker; external cost falls on third parties outside the compensated transaction. Social cost is private plus external cost. Marginal values refer to one extra unit; a total-cost figure cannot simply be drawn as a marginal gap. For a negative production externality, MSC lies above MPC, while MSB=MPB if consumption has no external effect.