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Economic Theory

or
External cost = social cost – private cost (8.2)

If social costs are greater than private costs, then a negative externality

is present.
Environmental pollution is an example of a social cost that is seldom

borne completely by the polluter thereby creating a negative externality. If
private costs are greater than social costs, then a positive externality exists.
An example is when a supplier of educational services indirectly benefits
society as a whole but only received payment for the direct benefit

received by the recipient of the education: the benefit to society of an
educated populace is a positive externality.
In either case, economists refer to this as market failure because

resources will be allocated inefficiently.
Economic Costs. Economic costs are the payments which must be
received by resource owners in order to ensure that they will continue to
supply them in the process of production. Economic cost includes normal

profit.
Short Run Costs and Long Run Costs. Short run is a period of time
within which the firm can change its output by changing only the amount

of variable factors, such as labor and raw materials etc. In short period,
fixed factors such as land, machinery etc., cannot be changed. Costs of
production incurred in the short run i.e., on variable factors are called short
run costs. The long run costs are the costs over a period in which all

factors are changeable. Thus, costs of production on all factors (in the long
run all factors become variable) are long run costs.

Fixed/Supplementary and Variable/Prime Costs. The expenses
incurred on fixed factors are called fixed costs, whereas those incurred on
the variable factors may be called variable costs.
The fixed costs include the costs of:

a) The salaries and other expenses of administrative staff;
b) The salaries of staff involved directly in the production, but on a
fixed term basis;

c) The wear and tear of machinery (standard depreciation allowances);
d) The expenses for maintenance of buildings;
e) The expenses for the maintenance of the land on which the plant is
installed and operates and

f) Normal profit, which is a lump sum including a percentage return
on fixed capital and allowance for risk.

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