1. State the formula for social cost. 2. Briefly define the components of the formula (private costs and external costs).
Full Answer
Social cost is the total cost to society of an economic activity. It is calculated by adding the private costs (the costs to the producer or consumer) and the external costs (the negative spillover effects on third parties).
In economics, the costs of production or consumption can be split. Private costs are those directly incurred by the individuals involved in the activity (e.g., a factory's cost for materials and labour). External costs (or negative externalities) are the costs imposed on third parties who are not directly involved (e.g., pollution from the factory affecting local residents). The social cost is the sum of these two, representing the true cost to society as a whole.
Common mistakes
Confusing social cost with just external cost, or just private cost. It is the sum of both.
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