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Private vs. Social costs

Explore the reasons behind divergences between private and social costs in markets, analyzing market failures, power, externalities, and policy distortions. Learn how to assess divergences' effects on consumers, producers, government budgets, and third-party costs. Dive into real-world examples and welfare effects of negative externality divergence and sales tax distortions.

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Private vs. Social costs

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  1. Private vs. Social costs Divergences • Market prices do not reflect opportunity costs • Private = market prices • Social = opportunity costs to society

  2. Reasons for Divergences • Market Failures • Market power • Externalities • Incomplete property rights • Including missing markets (non-exclusion, non-rival) • Distortions – result of policies that affect prices of commodities or factors • Commodity taxes/subsidies • Marketing restrictions/regulations • Taxes on economic activities • Etc.

  3. Market analysis of divergences • Need to consider effects on • Consumers (CS) • Producers (PS) • Government budget (B) • External effects or third-party costs (EE)

  4. Examples of market analysis • Market failures • Market power • Externalities • Market distortions (policies) • Domestic markets (no trade) • Commodity taxes/subsidies • Quantitative restrictions • International trade (small country) • International trade (large country)

  5. Welfare Effects of Negative Externality (Divergence) CS0=abc PC0=dbg a Ss PS0=cbd EE0=0 m Sp CS1=akh b c P0 PC1=fhl h j k P1 PS1=khf EE1 =-dmhf ∆CS=+cbhk D ∆PS=+djhf - cbjk d ∆EE=-dmhf f g l ∆Net=-bmh Q0 Q1

  6. Welfare Effects of Sales Tax (Distortion) CS0=abc P a PS0=cbd B0=0 S CS1=aef f PS1=hgd P’C e b B1=fehg c P P’p h g Unit Tax ∆CS=-febc ∆PS=-cbgh D ∆B=+fehg d D’ ∆Net=-ebg Q’ Q Q

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