BE/U4 Topic 5 Private and Social Cost
The Private Cost is the cost related to the working of the firm and is used in the cost-benefit analysis of the business decisions. These costs are borne by the firm itself.
The private cost is the actual cost incurred in performing the day to day operations of the business, such as the cost involved in the production and consumption of the product. For a firm, all the actual costs incurred, both implicit (depreciation, interest, insurance, etc.) and explicit (raw materials, wage, rent, salaries, etc.) are private costs.
For example, In the case of an FMCG company, the private cost will include, the cost incurred in transporting finished goods from the factory to the consumer, the cost of labor engaged in direct production, packaging cost, advertising cost, etc. All these costs are internal costs of the firm and are incorporated in the firm’s total cost of production.
The private cost incurred by either an individual or a firm yields private benefits for each. The private benefit is the reward an individual or a firm gets in return of goods and services. In the above example, the private benefit is the revenue generated by the FMCG firm from the sale of its products.
The Social Cost is the cost related to the working of the firm but is not explicitly borne by the firm instead it is the cost to the society due to the production of a commodity. The social cost is used in the social cost-benefit analysis of the overall impact of the operations of the business on the society as a whole and do not normally figure in the business decisions.
The social cost includes both the private cost and the external cost. The external costs are those costs which are directly related to the production and consumption of the commodity but is not directly paid by the producer. These are the costs borne by the society and therefore is called as the social cost.
Usually, the factories and mills located within the city cause pollution, both air, and water. For example, Mathura Oil Refinery discharging its wastes into river Yamuna is contaminating the water thereby causing the water pollution.
Thus, the social costs include:
- The cost of natural resources for which the firms are not required to pay, for example, river, lake, atmosphere, etc.
- The use of public utility services such as roadways, drainage systems, etc.
- The cost of ‘disutility’ created through pollution (air, water, noise, environment).
It is assumed that the disutility created through pollution is equal to the total private and public expenditure incurred by the firm to safeguard the public from the health hazards and social tension created by the production process. But however, these indicators, total cost, and public expenditure, does not give a true measure of the public disutility or the social cost.
Noise pollution and accident proneness are some other social costs due to rising traffic in big cities. While computing social costs, market prices of goods and factor of production are adjusted as social and shadow prices.
Social cost is the sum of private cost and external cost. Alternatively, external cost is the difference between social cost and private cost, which may be positive or negative. If social cost is more than private cost, there is an external cost (or. negative externality). On the other hand, if social cost is less than private cost, there is an external benefit (or positive externality).
Social cost is an important concept. Knowledge of social cost and social benefit is extremely important in the efficient utilisation of limited resources. The concept of social cost can be linked with opportunity cost to which we now turn.