PSCI 1500: Introduction to

Economics

Social Cost & Social Benefits

BENEFITS & COSTS: THE INDIVIDUAL

Defining Benefits & Costs

• Cost-Benefit Analysis - Weighing the costs and benefits of an action in order to maximize the net benefit from the action.

• Utility - Satisfaction realized from the consumption of a good or service.

• Opportunity Cost - Cost of acquiring a good or service measured in terms of the value of the opportunity or alternative foregone.Everything one does has an opportunity foregone

BENEFITS & COSTS: THE INDIVIDUAL

Measuring Benefits & Costs

Marginal Benefit (MB)• Also called marginal utility.• Change in total satisfaction from

consuming an additional unit of a good, service, or activity.

Total Benefit (TB)• Also called total utility.• Total amount of satisfaction received from

consuming a specified number of units of a good, service, or activity.

BENEFITS & COSTS: THE INDIVIDUAL

Law of Diminishing Marginal Utility

• As additional units of an item are consumed, beyond some point each successive unit of the item consumed will add less to total utility than was added by the unit consumed just before it.

BENEFITS & COSTS: THE INDIVIDUAL

Measuring Benefits & Costs

Utility Points from Attending a Concert

BENEFITS & COSTS: THE INDIVIDUAL

Measuring Benefits & Costs

Marginal Cost (MC)Change in total cost from each additional unit of a good, service, or activity produced.

Total Cost (TC)Cost of producing a specified number of units of a good, service, or activity.

BENEFITS & COSTS: THE INDIVIDUAL

Measuring Benefits & Costs

Total and Marginal Costs of Attending a Concert

BENEFITS & COSTS: THE INDIVIDUAL

Maximizing Satisfaction

• Net Benefit• Results when total cost is subtracted from total benefit. (Net Benefit = TB – TC)

• Maximizing Satisfaction Using The Net Benefit Maximizing Rules• Net benefit is maximized where total benefit exceeds total cost by the greatest amount, or where marginal benefit equals marginal cost.

BENEFITS & COSTS: THE INDIVIDUAL

Conditions under Net Benefit Maximization Rule

• Net benefit increases as long as marginal benefit is greater than marginal cost (MB>MC), no matter how small the difference.

• Net benefit decreases when marginal cost becomes greater than marginal benefit (MC>MB) because more is subtracted than is added to satisfaction.

BENEFITS & COSTS: THE INDIVIDUAL

Maximizing Satisfaction

Benefits and Costs of Attending a Concert

BENEFITS & COSTS: THE BUSINESS

Measuring Revenues and CostsTotal Revenue (TR)

• Revenue received from selling a certain quantity of an item.• Calculated by multiplying the price of an item

by the quantity demanded at that price.

Marginal Revenue (MR)• Change in total revenue when one more unit of an item is demanded.

BENEFITS & COSTS: THE BUSINESS

Measuring Revenues and Costs

Example : Revenues from Selling Chairs

BENEFITS & COSTS: THE BUSINESS

Measuring Revenues and Costs

Example : Costs of Producing Chairs

BENEFITS & COSTS: THE BUSINESS

Maximizing Profit

• Profit or LossResult when a business subtracts its total cost from its total revenue.

Profit Maximizing RulesProfit is maximized at the output level where total revenue exceeds total cost by the greatest amount, or where marginal revenue equals marginal cost.

BENEFITS & COSTS: THE BUSINESS

Maximizing Profit

Revenues, Costs, and Profit on Chairs

SOCIAL BENEFITS & COSTS

Social Benefits & Costs Externality

Effect of an action on a person or thing that was not one of the primary parties to the action.

Positive ExternalityExternality that creates a benefit for others.

Negative ExternalityExternality that creates a cost for others.

SOCIAL BENEFITS & COSTS

Maximizing Society’s Net Benefit

• Social Benefits & Costs• Total effect of society from the private benefits, private costs, and externalities of an action.

• Private benefits + positive externalities = social benefits

• Private costs + negative externalities = social costs• Social benefits – social costs = net benefit to society

SOCIAL BENEFITS & COSTS

Maximizing Society’s Net Benefit

Relationship between private and social net benefits

When production generates negative externalities, society’s net benefit is maximized by cutting back on the output level, and vice versa.

SOCIAL BENEFITS & COSTS

Government Policies to Maximize Society’s Net Benefit

• Fines, increase in tax• Outright prohibition from producing, • any relevant campaign or penalties to

provide the economy with positive externality or reduce the negative externality.

TEST YOUR UNDERSTANDING

What is referred as negative externality? Positive externality? Give example.

Negative externality is the costly effects of an action on a person or thing that was not one of the primary parties to the action. Example : non-halal products to Muslims, drugs, cigarettes, pollution etc.

Positive externality is the beneficial effects of an action on a person or thing that was not one of the primary parties to the action. Example – education, safety measure, healthy lifestyle etc.

How does the government policy respond to the case of externalities?

Government policies main objective is to maximize society’s net benefit.

fines, increase in tax, outright prohibition/ban or restrict production, campaign or penalties to reduce the negative externality.

subsidize or give incentive for the production generating positive externality.

TEST YOUR UNDERSTANDING