Private cost

The private cost is any cost that a person or firm pays in order to buy or produce goods and services. This includes the cost of labour, material, machinery and anything else that the person of firm physically pays for. The private cost does not take into account any negative effects or harm caused as a result of the production.

Figure 1. A coal fired power plant in England.

As an example, firm that operates a coal-fired power plant only considers the cost of what goes into producing the electricity: such as the cost of coal, labour to operate the plant, etc. The plant produces harmful emissions such as CO₂, particulate matter, and others. These emissions have a negative effect on society, pollution increases the amount of respiratory illness incidences which in turn increases the burden on the healthcare system. This "external cost" is paid by the government or the healthcare system.

Because the firm does not pay the cost for the harm, they create an "inefficiency" in the market, this inefficiency is called a negative externality. The inefficiency can be corrected if the firm pays the private cost of production and the cost imposed on society from the emissions (the external cost). If the firm pays both of the costs, it is paying the "social cost," meaning that it has accounted for the harmful effects that were previously not considered. The social cost is the total cost: private and external.

The cost of production would rise to a "socially efficient level" (meaning there is no externality) if: the firm took additional measures to lower or eliminate the amount of emissions from generation. In this example, the firm could invest in new air pollution control devices to lower emissions. However, the new investment makes the generation of electricity more expensive and therefore the price the firm sells their electricity for would rise.

See Also

• Market failure
• Pollution
• Deadweight loss
• Positive externality
• Negative externality
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