Marginal Social Cost

Updated on April 5, 2024
Article byPriya Choubey
Edited byPriya Choubey
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Marginal Social Cost (MSC)?

Marginal social cost (MSC) is an economic concept that measures the additional expenses incurred by society when a corporation produces an additional unit of goods or provides services within the economy. It serves as a gauge for assessing the overall social impact of a company’s production activities.

Marginal Social Cost

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Source: Marginal Social Cost (wallstreetmojo.com)

MSC encompasses both the private costs borne by producers and consumers and any external costs or benefits that have an impact on the overall welfare of society. This comprehensive measure plays a crucial role for policymakers in determining the optimal level of production or consumption of goods and services from a societal perspective.

Key Takeaways

  • Marginal social cost (MSC) is an economic principle that quantifies the loss borne by society when a subsequent unit of a good or service is produced or consumed in the economy.
  • The MSC formula is: Marginal Private Cost (MPC) + Marginal External Cost (MEC).
  • When MSC is more than MPC, it signifies the adverse effect of production or consumption on the society, ecosystem, and environment, I.e., the negative externalities.
  • However, a positive externality can be achieved when the MPC is higher than the MSC, which indicates that such a production is not very harmful to society.

Marginal Social Cost Explained

The marginal social cost is a qualified cost born by society for the production of additional units of something. It is essential for the government and policymakers to determine the true price of manufacturing and producing a single product unit. This cost includes private production costs, such as labor, materials, and capital, directly shouldered by producers.

It also incorporates any external costs or negative externalities associated with producing or consuming an additional unit of goods or services. These external costs could include pollution, congestion, contamination, or other societal and environmental costs not reflected in the product’s market price. Conversely, if the production or consumption of a good indicates positive externalities, such as education or research and development, the MSC would include the private costs and the external benefits to society.

Accounting for private costs and externalities enables policymakers to make more informed decisions about resource allocation and implement regulations or taxes to address negative externalities while promoting social welfare. Also, without externalities, the marginal private cost equals the marginal social cost. But, in reality, externalities are prevalent, resulting in disparities between private and social costs and benefits. These disparities can lead to market failures, such as overproduction or underproduction of goods and services, leading to inefficiencies. 

However, the marginal social cost has a major drawback, I.e., it considers both the tangible and intangible costs. Thus, it is easy to determine the tangible cost, I.e., the marginal private cost of production or consumption in a monetary value, but the intangible cost, I.e., the marginal external cost or impact of that production or consumption over the society, is not easily quantifiable.

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How To Calculate?

The formula used for the evaluation of marginal social cost is:

MSC = MPC + MEC

  • MSC → Marginal Social Cost
  • MPC → Marginal Private Cost
  • MEC → Marginal External Cost

Given below are the basic steps involved in determining the MSC:

  1. Compute the marginal private cost (MPC) of producing or consuming a subsequent unit of product or service.
  2. Ascertain the marginal external cost (MEC) incurred by the society when one more output unit is generated.
  3. Add the values of MPC and MEC evaluated in the previous steps to acquire the value of MSC.

Curve

The marginal social cost of producing or consuming another unit of a commodity can be graphically represented as follows:

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Source: Marginal Social Cost (wallstreetmojo.com)

The graph’s vertical axis represents cost or price, while the horizontal axis represents quantity or output. The graph shows the relationship between marginal social cost (MSC) and quantity.

  • Ps represents the social price, which is the price that would reflect the MSC and benefit received by society.
  • Pp represents the private price, which is the price determined by the market based on the marginal private cost (MPC) and benefit.
  • Qs represents the social output, the quantity of the good or service produced or consumed if the market accounts for all social costs and benefits.
  • Qp represents the private output, which is the quantity of the goods or services produced or consumed in the market.

MSC is the curve representing the marginal social cost, which includes both the private costs (MPC) and external costs (MEC) associated with producing or consuming each additional unit of the good or service.

MPB is the marginal private benefit, representing the additional benefit consumers receive for each additional unit consumed. MSB is the Marginal Social Benefit, representing the additional benefit to society for each additional unit consumed.

Marginal external cost (MEC) is represented by the vertical distance between the MSC curve and the MPC curve at the equilibrium point, where the marginal private benefit (MPB) equals the marginal social benefit (MSB).

Examples

Let’s look into some examples for a better understanding of the concept:

Example #1

Let’s consider a factory that produces widgets. The private cost for the factory to produce one widget includes expenses such as raw materials, labor, and electricity, which amount to $5 per widget (MPC).

However, the production process of widgets generates pollution, which imposes a cost on society. For instance, let’s say that the pollution caused by each widget leads to an additional cost of $2 to mitigate its environmental impact (MEC).

To determine the marginal social cost (MSC) of producing an additional widget, we add the private cost (MPC) and the external cost (MEC):

MSC = MPC + MEC

MSC = $5 + $2 MSC = $7

Therefore, the marginal social cost of producing one more widget is $7. This means that when considering the overall social impact, including both private costs and the external cost of pollution, the factory should consider a cost of $7 for each additional widget produced.

Example #2

Suppose a paper company has a marginal private cost of $40 for an additional quintal of paper produced, and the society incurs a marginal external cost of $60 for every extra quintal of paper produced because of damage to the ecosystem from cutting down trees. First, determine the marginal social cost.

MSC = MPC + MEC

MSC = $40 + $60 = $100

Thus, the marginal social cost of producing one more quintal of paper is $100.

Marginal Social Cost vs Marginal Private Cost vs Marginal Social Benefit

Marginal social cost (MSC), marginal private cost (MPC), and marginal social benefit (MSB) are economic concepts that play a crucial role in assessing the costs and benefits associated with the production and consumption of goods and services. The three terms differ from one another in the following ways:

BasisMarginal Social CostMarginal Private CostMarginal Social Benefit
MeaningThe cost incurred by individual producers or consumers for an extra unit.Adverse effects on the environment, health, infrastructure, etc.Additional utility society gains from consuming an extra unit.
IncludesMSC = MPC + MEC, incorporating private and external costs.MPC includes explicit and implicit costs of production or consumption.MSB involves private benefits and external benefits to society.
ReflectsCorrelationDirect costs of producers or consumers.MSB involves private benefits and external benefits to society.
CorrelationMSC > MPC due to external costs.MPC < MSC (part of MSC evaluation).The cost incurred by society for producing or consuming an additional unit.

Frequently Asked Questions (FAQs)

1. When is marginal private cost greater than marginal social cost?

The MPC is more than the MSC only when a positive externality exists. It indicates that the company has knowingly or unknowingly eliminated the cost to society and other organizations.

2. How can marginal social costs be reduced?

It is essential to curtail the MEC to bring down the MSC of producing or consuming a good or service. Companies can take eco-friendly production measures to compensate for and eliminate the societal impact of such negative externalities. Also, the government and policymakers impose various taxes and penalties on the industries to recover the marginal external cost.

3. What is the importance of the marginal social cost of carbon?

The carbon dioxide emission by factories during various manufacturing and production activities is dangerous. It pollutes the atmosphere and results in climate change. Thus, the policymakers and other decision-makers determine the MSC of Carbon using the benefit-cost analysis.

This has been a guide to what is Marginal Social Cost. We explain how to calculate it, its graph, examples, and comparison with marginal private cost. You can learn more about it from the following articles –

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