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External costs versus private costs: Why is the difference between the two important?
In economic activities, the definition of cost is usually the value of resource use. It has been used to produce a certain product or provide a certain service, and therefore cannot be used for other purposes. Costs in business may include acquisition costs, which are money spent to obtain a good or service. In this case, money is the input consumed in order to obtain the item. These costs are not only the production costs of the producer, but also include other transaction costs incurred when purchasing. Usually, the price also includes a certain profit, plus the cost of production, which leads economists to consider the concept of cost as a standard model in the economic process.
Cost is a metric used in economic processes to measure results or make decisions.
Types of accounting costs
In accounting, cost refers to the monetary value of supplies, services, labor, products, equipment, and other items expended for a business or other accounting entity. These costs are typically shown as prices on invoices and treated as expenses or asset cost basis in bookkeeping records. Opportunity cost, also known as economic cost, refers to the value of the best alternative not chosen to pursue the current task, that is, other possibilities that can be achieved by the resources used. Opportunity cost represents the opportunity forgone.
Compare private costs, external costs and social costs
Whenever a transaction occurs, there are usually private costs and external costs involved. Private cost refers to the cost paid by the buyer to the seller for the purchase of goods or services, which can be described as a cost internal to the enterprise's production function. In contrast, external costs (also called externalities) refer to the costs that others other than the buyer must bear. These costs may be borne by individual individuals or shared by society as a whole. External costs are often non-monetized and difficult to quantify for comparison.
Social cost is the sum of private costs and external costs.
For example, the costs of manufacturing a car (such as purchasing raw materials, factory land taxes, factory overhead costs, and labor costs) reflect the manufacturer's private costs. However, contaminated water or air pollution from the production of cars are external costs that are borne by affected individuals or by societies that value unpolluted air and water. Because the manufacturer does not pay for these external costs and does not include them in the price of the vehicle, these costs are considered external to the market pricing mechanism.
Cost estimate
When developing a business plan for a new company, product, or project, planners often perform cost estimates to assess whether revenues/benefits will cover the costs (see cost-benefit analysis). This is a common practice in both business and government, however, costs are often underestimated, leading to cost overruns during implementation. Cost-plus pricing is when the price is equal to cost plus a percentage of overhead or profit margin.
In a business economy, the profitability of a trade or sales prospect depends on the business maintaining market prices that cover all costs and leave a surplus for the benefit of the owners.
Manufacturing costs and non-manufacturing costs
Manufacturing costs are those costs directly related to the production of a product, such as raw material costs and worker-related expenses. Manufacturing costs can be further divided into three broad categories: direct material costs, direct labor costs, and manufacturing overhead. In contrast, non-manufacturing costs are those costs that are not directly involved in producing the product, such as sales staff wages and advertising expenses. Non-manufacturing costs are generally divided into two categories: selling and distribution costs and administrative costs.
Other costs
Defensive costs refer to environmental expenditures used to eliminate or prevent environmental damage. These defensive costs are part of the Real Progress Indicator (GPI) calculation. Labor costs include travel time, vacation pay, training costs, work clothes, social insurance, employment taxes, etc. Path cost is a term in networking that defines the value of a path, often used in routing.
Conclusion
In summary, understanding the difference between private costs and external costs is critical for both business and society, as it affects not only business decisions but also the formulation of public policy. As we face increasingly serious environmental problems and social challenges, it becomes necessary to consider these costs comprehensively. So, how should we balance private costs and external costs more effectively in future economic development?
