Marginal Social Benefit: Basics of Microeconomics

Marginal Social BenefitMarginal social benefit is an important concept in microeconomics that describes the net social value of any product, activity or service. Understanding how this concept affects the price, production and consumption of any product is one of the fundamental problems in microeconomics.

This article will give you a thorough understanding of marginal social benefit and related concepts. To learn more, check out this course on micro and macroeconomics.

What is Marginal Social Benefit?

Externality

Before we can understand marginal social benefit, we need to understand the concept of externality.

In Economics, externality describes the cost or benefits of any activity experienced by an unrelated third party. For example, an electronics factory releases harmful chemicals into a river. The river provides water to residents of a nearby town. Thus, even though the town residents are not paying for, or benefiting from the electronics factory, its existence is still affecting their quality of life.

Externality may be either positive or negative.

  • Positive externality describes an activity that leaves a positive effect on a third party.
    For example,a college decides to slash its tuition rates by half. This encourages more people to get educated. A better-educated workforce, in turn, helps businesses produce more. Thus, even though the businesses did not pay for the reduced college tuition, they still reap a positive external benefit from the college’s move.
  • Negative externality describes an activity that leaves a negative impact on an unrelated third party. For example,any industrial activity that releases harmful pollutants into the environment can be said to have negative externality. A factory that spews carbon compounds into the atmosphere promotes global warming, which, in turn, affects seasonal cycles, destroys wildlife habitats and causes climate change.

Private and External Benefits

Based on the above, we can say that every activity has benefits/costs that work on two levels:

  • Private: The total benefits/costs incurred by the individual producing or consuming the product or service directly. A consumer buying a car, for instance, is paying for the car alone and not for the pollution it will cause.
  • External: The total benefits/costs associated with any activity incurred by a third party. For example, by buying a car, the consumer is able to reach his workplace faster. This improves his productivity, benefiting the business (positive externality). At the same time, the consumer’s car causes significant pollution, which affects the quality of life of other residents in the city (negative externality).

We can now say that every activity has private and external benefits and costs. But what exactly does marginal benefit/cost mean? This is a complicated concept, but we’ll try to distill it down to its very basics. For a more detailed explanation, check out this course on economics without boundaries.

Marginal Benefits and Costs

Economists believe that all consumers and producers make their decisions at the margins. That is, consumers and producers make every economic decision based on its marginal benefit/costs over similar options.

As an example, suppose that you need a new microwave and a new coffee machine. However, you have just about enough cash for only one of these appliances. You must now decide which of the two products to buy.

While making the decision, you might consider the following

  • The marginal benefit to be gained from buying a new microwave as opposed to using your existing microwave for a few more months.
  • The marginal benefit of a coffee machine over a microwave, and vice-versa.
  • The marginal benefit of buying either of the two appliances right now as opposed to waiting a few more months until you have enough savings.
  • The marginal buying power you must give up to purchase either of the two appliances. Perhaps you will have to delay your summer vacation by a couple of weeks, or maybe you will have to cut down on your Christmas shopping to make way for the new microwave/coffee maker.

Of course, it rarely works out in such a regulated manner, but most buying decisions involve a somewhat similar thought process. Since all decision making happens at the margins, Economists call it marginal benefits and marginal costs.

Technically speaking, marginal benefits is defined as the total benefit reaped from consuming or producing “one more unit” (i.e. at the margins) of any product or service.

With this out of the way, we can get down to defining marginal social benefits.

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Marginal Social Benefits Defined

We now know that every activity has private as well as external benefits. We also know that benefits and costs are usually described at the margins, i.e. marginal benefits/costs.

Combining these, we can say that marginal social benefits can be defined as the sum total of the marginal private benefits and marginal external benefits associated with any activity.

Mathematically, it is expressed as the sum of marginal private benefit (MBprivate) and marginal external benefit (MBexternal).

Thus, we have:

MBsocial = MBprivate + MBexternal

For example, selling a car reaps a car company a profit of $5,000. However, in producing a single car, the car company releases pollutants that cause climate change and affect local farmers. The total negative costs of this pollution is estimated to be $1000 per car.

Thus, we have:

MBprivate = $5000

MBexternal = -$1000

Therefore,

MBsocial = $5000 + (-$1000)

= $5000 – $1000

= $4000

Of course, calculating marginal social benefit in the real world is far more complicated. Purchasing a car might improve the consumer’s mobility and efficiency. The presence of an active car factory might also spur local commerce and generate jobs, and so on.

This is just the tip of the iceberg as far as microeconomics is concerned. You can learn a lot more about externalities and marginal benefits and costs in this course on CFA Level 1 economics.