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A negative externality exists when:
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7. Externalities
Externalities: Social Benefits and Social Costs
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Which of the following statements best describes the relationship between social cost and external cost?
A
Social cost only refers to the costs incurred by producers.
B
Social cost includes both private cost and external cost.
C
Social cost and external cost are synonyms; they refer to the same concept.
D
External cost is always greater than social cost.
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Step 1: Understand the definition of private cost, which refers to the costs incurred directly by producers or consumers involved in a transaction.
Step 2: Define external cost as the cost imposed on third parties or society that is not reflected in the market price, such as pollution or noise.
Step 3: Recognize that social cost is the total cost to society, which includes both the private cost and the external cost.
Step 4: Express the relationship mathematically as: \(\text{Social Cost} = \text{Private Cost} + \text{External Cost}\).
Step 5: Use this understanding to evaluate the given statements and identify that social cost encompasses both private and external costs, making the statement 'Social cost includes both private cost and external cost' the best description.
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