Micro CHAPTER 6.1:

CHAPTER SUMMARY

Up until now, we have focused on the utility of individuals and the profits of businesses. However, economists also study society as a whole, by measuring social benefit and social cost, the positive and negative impact of decisions on all of society. Many times, free markets are able to produce outcomes that are socially efficient or socially optimal, giving us the maximum benefit to society possible. However, other times, free markets produce socially inefficient outcomes, meaning that they do not produce the maximum utility possible for society.

To understand how to analyze this, we need to understand the concept of marginal social benefit (MSB). When a consumer buys something, they usually receive most of the benefits themselves, but it can also provide utility to people around them or decrease the utility of society. 

For example, if my neighbor buys a snow shovel, they receive some utility from being able to shovel the snow on the sidewalk in front of their house. However, I also benefit from this because I can now walk safely on that sidewalk after it snows. These positive effects on people who did not actually participate in the transaction are called positive externalities. In this case, the MSB is higher than just the utility my neighbor received - it is the utility my neighbor received from buying the snow shovel plus the marginal utility of all of the rest of us who are now able to use their sidewalk.

On the flipside, if I buy an extremely loud motorbike, I may receive a lot of marginal utility if I love riding motorbikes. However, if my neighbors find the loud motorbike annoying and it keeps waking them up, the MSB is the marginal utility I received from buying it, minus the marginal utility each of my neighbors lose because of the motorbike. This situation is an example of a negative externality, when people not involved in a transaction are negatively affected.

Similar situations can occur with production. If a factory spends $1,500 to produce my motorbike, but they also have to pollute the environment to do so (another negative externality), then the marginal social cost (MSC) would be $1,500 plus the cost to society of their pollution.

Ultimately, the MSB curve looks very similar to the demand curve, but it could be higher or lower than the demand curve depending on whether purchasing something has mostly positive or negative externalities. Similarly, the MSC curve looks a lot like the supply curve, but could be slightly higher or lower depending on the externalities that come with production.

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