Environmental Economics - Construction Economics: A New Approach - page 184

PRIVATE COSTS VERSUS SOCIAL COSTS
When environmental economists talk about costs they fall into three categories:
private, external and social. First, there are the costs of an individual's actions that
are known and paid for directly. For example, when a business has to pay wages to
workers, it knows exactly what its labour costs are. When it has to buy resources to
commence production, it knows what these will cost. Similarly, when tenants have
to pay rent for their flat, they know exactly what the cost will be. These are the
normal everyday costs associated with most traditional economic activity; they are
called private costs and formed the focus of Part A. They were formally introduced
in Chapter 2 (see Key Points 2.4) . Private costs are those borne solely by the
individuals who incur them. They are internal in the sense that the firm or household
must explicitly take account of them.
Second, there are external costs , created by the actions of other people. (These
have also been discussed previously in Chapters 2 and 10, so it might help to review
Key Points 2.4 and 10.1. ) We have considered situations in which a business dumps
the waste products from its production process into a nearby river, and individuals
drop litter on a beach. Obviously, there is a cost involved in each of these actions.
When the firm pollutes the water, people downstream suffer the consequences. They
may not want to swim in the river or drink the polluted water. In the case of fly
tipping or simply common litter, the people who come along after the waste has
been dumped are the ones who bear the costs. The costs of these actions are borne
by people other than those who commit them. The polluter has not paid, the costs
have not been internalised; they are, by result, referred to as external costs.
When we add the external costs to the internal or private costs, we arrive at
the third category - total or social costs . Pollution - as all problems pertaining to
the environment - may be viewed as a situation in which social costs exceed private
costs. Because some economic participants do not pay the full costs of their actions
but only their (lower) private costs, their actions are 'socially unacceptable'. If there
is a divergence between the social and private costs of a specific activity, we may
see 'too many' resources allocated to that activity. To take just one of the many
examples, when drivers step into their cars, they certainly don't pay the full social
costs of driving. They pay for petrol (which includes a significant element of fuel
duty), maintenance, depreciation, road tax and insurance on their cars. However,
they cause an additional cost - that of air pollution - which they are not forced
to take fully into account when they make the decision to drive. The air pollution
created by exhausts is a cost that drivers do not bear directly, but it causes harm
to other individuals who suffer the inconvenience of respiratory ailments, and dirtier
clothes and buildings. The social cost of driving includes all the private costs plus the
external costs such as the costs of air pollution, which society bears. Decisions made
only on the basis of private cost, therefore, lead to 'too much' driving!
Externalities
As we know from Chapter 10 , when a private market cost differs from a social cost
it is a problem of externalities - individual decision-makers are not internalising all