Cost and benefit analysis is a finding of what is
best for the society by calculating total cost and total benefits
Example:
Steel Manufacturing factory: Cost Value = $ 100000
So analyzing this cost and benefit value it is
decided whether to do this activity or not.
The cost and benefits are of different types
Cost
1) Private Cost:
A) Amount of money individual
spend over a product is private cost. Example cost of cigarette is MRF2
B) Disadvantage to individual
due to economic activity is private cost. Example Smoking leads to Asthma or
Cancer.
2) External Cost: Disadvantages to third person who are not involved
either production or consumption of goods. Example the smoke emitted from
cigarette may harm to other person around who does not smoke.
3) Social Cost: It means disadvantages to whole society due to production
of goods and services. It includes Private Cost + External Cost. Example
producer who produce cigarettes has to live in the same environment. Consumer
who smoke will have to face the problems of smoking and the third person who is
around is also having disadvantage due to this economic activity.
Benefits
1) Private Benefit: These are the
advantages to a person / individual due to an economic activity. Example
Producers get profit by selling cigarette and consumer’s gets satisfaction
after smoking.
2) External Benefits: These are advantages to 3rd person due to
economic activity. Example employment increase.
3) Social Benefits: It is the advantages to whole society due to economic
activity. Private + External benefits = Social Cost.
Conclusion: Government calculates cost and benefit
analysis and based on reports give permission / license to start any project.
Marginal Cost and benefits
The difference between social costs and social
benefits changes as the level of output changes. This can be shown using
marginal analysis. The margin is a possible point of change. So the marginal
cost of production is the extra cost of producing an extra unit of output. The
marginal benefit is the benefit received from consuming an extra unit of output.
The marginal cost of production will first decrease,
as more output is produced indicating greater efficiency. However, as more
output is produced, marginal cost will increase. This may be because the firm
may have to pay more for the acquisition of factors of production. (Producing
beyond capacity, hiring more labour)
In contrast, marginal benefit will decrease as more
goods are consumed the marginal benefit curve is also same as demand curve.
The social optimum and free market optimum through
external cost or external benefit.
Negative
externalities/External Cost
External costs are costs incurred to third parties
not involved in a trisection. It is the difference between social cost and
private cost. Exist when the social costs of an economic action are greater
than the private costs. For example, a toy manufacturer located on the banks of
a river will incur a number of private costs of production (example raw
materials, labour, running machinery etc) but may also impose costs on third
parties, such as noise from delivery lorries and an ugly factory affecting the
quality of life of local residents or pollution being pumped into the river.
Social costs = private costs + external costs.
X is free market optimum level of output
Y is the social optimum level of output
The free market optimum level of output is where
marginal social benefit is equal to marginal private cost. This is also known
as market equilibrium. However, social optimum output is less than free market
level of output. It is output Y. the production and consumption takes places at
OX, which is higher than the social optimum level creating a welfare loss to
the society. The loss is the vertical difference between MSC and MSB. The
triangle which forms in this distance is called welfare loss triangle.
Positive
Externalities/ External Benefits.
Positive externalities or external benefits are
benefits enjoyed by the third parties not involved in a transaction. It is the
difference between social benefits and private benefits. It exists when the
social benefits of an economic action are greater than the private benefits.
For example, the education received by a child means that he or she can get a
job which pays a reasonable income (i.e. there is a private benefit to
education); however, that child’s education may also benefit wider society if
he or she become a doctor and is able to treat people so that they can return
to work (i.e. there is also a social benefit).