ECO205Y5 Chapter Notes - Chapter 16: Private Military Company, Cengage Learning, Social Cost

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24 Aug 2013
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An externality is an effect of one economic actor"s activities on another actor"s well-being that is not taken into account by the normal operations of the price system. For efficient allocation of resources, price = social marginal cost of production (msc) Social cost is the cost of production that includes both input costs (private costs) plus the costs of the externality. A firm will maximize profits by producing at price = marginal private cost (mc) If production involves a negative externality the marginal social cost is greater than the marginal private cost. Therefore, profit maximizing behavior (p=mc) will lead to too much output being produced compared to the allocatively efficient outcome (p=msc). The vertical gap between the mcs and the mc curves measures the harm that producing an extra unit of charcoal imposes on eyeglass makers. At q*, the social marginal cost of producing charcoal exceeds the price people are willing to pay for this output (p*).

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