Private and Social Cost Benefit

Whenever we try to start a project or a company, we always do the analysis whether it is beneficial or not. There are three kinds of costs and Benefits that we should analyze

1. Private Costs and Benefits

2. Social Costs and Benefits

3. External Costs and Benefits

To understand this we would take an example:

The wild life forests, in the region of Uttaranchal, are being cleared by company XYZ at a relatively rapid rate. The company has hired workers to cut the trees. The trees are transported using trucks to the furniture market where they are used for making furniture. XYZ Company has built roads in wild life forests for faster transportation.

Private Costs and Benefits

Private Costs:

Private costs are the costs borne by those who are directly involved in the decision to produce a product. In the case of a XYZ company, private costs will include, for example, the cost of transporting the wood and the cost of labor

Private Benefits:

Private benefits are the benefits received by those directly involved in the consumption and production of a product. The private benefit for XYZ Company would be revenue earned from selling the wood Company XYZ might only consider private costs and benefits and as long as the private benefits exceeds the cost, the company will keep on cutting the trees.

External Costs and Benefits

When firms produce products and households consume them, they often affect other people. For example, someone smoking in a factory may harm the health of other workers and a clothing firm, that dumps waste into a river, may damage the fishing stocks of a fish farmer and harm the environment.

These kinds of costs are often not considered while doing a feasibility analysis for the project.

External Costs:

The negative effects on third parties, due to the consumption and production activities of others, are known as external costs. In case of company XYZ, external costs due to cutting of trees may include damage to wildlife habitats, loss of plant species that could be used to develop medicines, global warming and interference with the lifestyle of local tribes

External Benefits:

The positive effects on third parties, due to the consumption and production activities of others, are known as external benefits.

 In Case of company XYZ external benefits may include reduced transport costs and reduced transport time for tourist firms in the area due to construction of roads by company XYZ

Social costs

Social costs are the total costs of an economic activity to society. The social cost of cutting down trees in the wild life forest, will consist of both external and private costs. When social costs exceed private costs, there are external costs involved.

Social benefits

Social benefits are the total benefits to the society, arising from an economic activity. They include both private and external benefits. Again, where social benefits are greater than private benefits, external benefits exist The level of output which will cause maximum benefit to the society and not only individual will occur when the social benefit of the last unit produced is equal to the social cost of that unit. If the social cost exceeds the social benefit, it implies that too many resources are being devoted to the production of the product

In our example, company xyz might only be considering the private costs and benefits and is keen on cutting more trees as it gives more profit. But if company XYZ also includes the external costs and benefits then it may realize that social costs in this case are greater than the social benefits..