7.4 Private costs and benefits, externalities and social costs and benefits

If a project has SC of $100m and PC of$40m, EC = $60m. If one extra flight has MPC of$5,000 and noise/congestion MEC of $2,000, MSC =$7,000. A reduction in fuel cost shifts MPC down; quieter design reduces MEC.

When a producer is required to repair or compensate for damage, the payment becomes a private cost and the remaining external cost falls: the cost is internalised rather than counted twice.

If a hospital has SB of $240m and EB of$150m, PB = $90m. If an additional vaccination gives MPB of$30 and MEB from reduced transmission of $20, MSB =$50.

A faster journey for the motorcyclist who switches mode is private benefit; reduced congestion for remaining drivers and cleaner air for pedestrians are external benefits. Identify who receives each effect before calculating.

The key test is whether the affected person is outside the buyer-seller decision and whether the spillover is omitted from the market price. Negative externalities usually cause overproduction or overconsumption; positive ones cause underproduction or underconsumption.

Noise from a nightclub is a negative consumption or production spillover depending on the source. A firm’s research that other firms learn from creates a positive production spillover.

Put price/cost/benefit on the vertical axis and quantity on the horizontal. Locate market output where MPB = MPC. Locate social output where MSB = MSC. Compare Qm with Q* and label the relevant curve gap as MEC or MEB.

Steel pollution separates MSC from MPC; discarded gum or smoking burdens separate MSB from MPB; training and vaccination can make MSB exceed MPB. The party outside the transaction determines the external component.

An activity can create more than one externality, such as production costs and consumption benefits. Compare the net positions of MSB and MSC; do not infer over- or underproduction from one spillover alone when another operates simultaneously.

On a marginal diagram, shade the area between MSB and MSC over the quantities separating Qm and Q*. With straight curves it is often a triangle. Label both quantities before choosing the area; the external-cost rectangle or a producer/consumer transfer is not automatically DWL.

DWL grows with the marginal social gap and with the output distortion. For a constant MEC, more elastic demand can produce a larger quantity difference and therefore a larger welfare triangle, other curves unchanged.

Before a transaction, hidden information can cause adverse selection; after it, hidden action can create moral hazard. Monitoring, contracts, deductibles and disclosure can reduce—but not always remove—the problem.

An insured driver may take less care because the insurer covers much of the loss. A larger excess or monitoring device makes the driver face more of the marginal cost.

Define the project and counterfactual; identify incremental private and external effects; value each without double counting; calculate SC, SB and net social benefit (NSB); compare feasible alternatives and choose the greatest reliable positive NSB, subject to the budget and other objectives.

If flood defences have PC $450m, EC$60m, PB $260m and EB$190m, SC = $510m, SB =$450m and NSB = -$60m, so they fail the basic social test on these estimates. For output choice, expand while MSB > MSC and stop where MSB = MSC.