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Marginal Social Cost (MSC)

The total cost impacted to society due to the production of an extra item

What is Marginal Social Cost (MSC)?

Marginal social cost (MSC) refers to the cost that society pays as a result of the production of additional units or utilization of a good or service. The total costs of producing an additional unit are not only undertaken by the producer but also by society. MSC examines the impact on society due to the production of additional units of output.

When a business fails to pay the marginal social costs arising from their activities, the social costs remain with the society. For example, when a factory drains waste into a town’s river, it pollutes the environment, and society must pay the cost of the polluted river.

 

Marginal Social Cost

 

Marginal social cost is a key principle that can be used by legislators and economists to develop an operational structure that can help companies to reduce the social costs of their production activities. Policymakers use MSC to develop various policies to control climate change.

For example, the social cost of carbon is the marginal social cost on the impacts created by emitting one additional ton of greenhouse gas. Generally, the social cost of carbon is an important concept determined to design a corrective measure on the effects of production activities on climatic change.

 

Summary

  • The marginal social cost (MSC) is the total cost impacted to society due to the production of an extra item.
  • When calculating MSC, both fixed and variable costs must be considered.
  • The marginal social cost can be used in developing a production structure that can help companies cut down the cost of their actions.

 

How Marginal Social Cost Works

The marginal social cost is an economic concept that reflects the costs incurred on the society by activities of production. Therefore, when analyzing MSC, the negative impact on society must be accounted for if the company is willing to uphold the integrity of corporate social responsibility (CSR). It is the responsibility of the business to benefit the society around it and the environment in general.

The decision to produce two different additional units of output will be determined by the company’s management after considering the marginal social costs and the marginal social benefits of either extra units. The calculation of marginal social cost involves taking the marginal cost paid by the company plus the external impact on society.

 

How to Calculate Marginal Social Cost

The marginal social cost is calculated as follows:

 

Marginal Social Cost = MPC + MEC

 

Where:

  • MPC is the Marginal Private Cost
  • MEC is the Marginal External Cost, which can be positive or negative

 

Examples of Marginal Social Costs

Marginal social costs can be compiled as the total sum of marginal private costs and marginal external costs associated with production. Therefore, to achieve an efficient economy, producers and consumers must analyze the full marginal social costs of consumption and production of each unit.

 

Marginal Private Costs

Marginal private costs refer to the costs that the company pays to acquire inputs of production. The costs are paid by the company or a consumer and are considered during consumption and production decisions. However, the willingness to pay for the cost depends on the marginal social benefit derived from each unit of output. A consumer may incur marginal private costs during maintenance and depreciation costs of a unit.

 

Marginal External Costs

Marginal external costs are not reflected in the business’ income statements or consumers’ decisions. However, society is the main victim of external costs. The external costs need to be included in the private costs when calculating the marginal social cost. It will generate a socially accepted rate of output. Generally, the marginal social cost is used as a tool for efficient pricing of production infrastructure after the internalization of external costs.

 

Costs of Marginal Social Cost

The following are the types of costs considered in calculating marginal social cost:

  • Fixed costs remain unchanged and do not fluctuate during the production period. Examples include rent, setup costs, and insurance.
  • Variable costs do not remain constant, and they change with an increase or decrease in production volumes. An example of a variable cost of the cost of purchasing raw material for use in the production process.

 

Solutions to Marginal Social Costs

The problem associated with marginal social costs reflects the negative activities carried out by a particular company. The company’s behavior outlines the difference between social benefits or costs and private benefits or costs.

The main solution towards solving such problems is to change the incentives and align private marginal costs with social marginal costs. For example, if the company’s private cost of pollution is equivalent to social marginal cost, then the management will generate the socially optimal payment of pollution.

Policymakers are required to develop structures for adjusting the incentives and compel businesses to combine the social marginal costs with their private marginal costs. Market signals should force polluters to consider how their activities are affecting society. However, government policies should provide incentives for businesses and enable them to internalize their negative effects.

 

Limitations of Marginal Social Cost

Marginal social cost can only identify costs that can be quantified in a tangible amount of money, such as costs incurred on production. However, the effects of production costs are hard to quantify in the exact amount of money.

 

Related Readings

CFI is the official provider of the Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to transform anyone into a world-class financial analyst.

In order to help you become a world-class financial analyst and advance your career to your fullest potential, these additional resources will be very helpful:

  • Analysis of Financial Statements
  • Fixed and Variable Costs
  • Marginal Benefit
  • Negative Externalities

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Become a certified Financial Modeling and Valuation Analyst (FMVA)® by completing CFI’s online financial modeling classes and training program!

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