Study Notes
Private costs and benefits are experienced by those directly involved in an economic decision, while externalities affect third parties not directly involved. Social costs and benefits represent the total impact on society, combining private and external effects.
- Negative Externality — Occurs when an action imposes unexpected costs on third parties. Example: Increased noise from additional flights affecting nearby residents.
- Positive Externality — Occurs when an action provides unexpected benefits to third parties. Example: A new vaccine benefiting the global population beyond the investing firm.
- Private Costs (PC) — Costs incurred by those directly involved in an action. Example: Development expenses for airport expansion.
- Private Benefits (PB) — Benefits received by those directly involved in an action. Example: Revenue from expanded airport facilities.
- External Costs (EC) — Costs imposed on third parties not involved in the action. Example: Noise pollution from airport expansion affecting local residents.
- External Benefits (EB) — Benefits received by third parties not involved in the action. Example: Reduced noise pollution for residents near a different airport.
- Social Costs (SC) — Total costs to society, including private and external costs. Example: The sum of development expenses and noise pollution costs.
- Social Benefits (SB) — Total benefits to society, including private and external benefits. Example: Combined revenue and reduced noise pollution benefits.
Exam Tips
Key Definitions to Remember
- Negative Externality
- Positive Externality
- Private Costs
- Private Benefits
- External Costs
- External Benefits
- Social Costs
- Social Benefits
Common Confusions
- Confusing private costs with social costs
- Misunderstanding the difference between external and social benefits
Typical Exam Questions
- What is a negative externality? It is an unexpected cost imposed on third parties by an economic action.
- How do private and social costs differ? Social costs include both private costs and external costs.
- What is an example of an external cost? Road congestion costs.
What Examiners Usually Test
- Understanding of the difference between private and social costs and benefits
- Ability to identify examples of externalities
- Calculation of social costs and benefits