• In a free market, the price mechanism determines the most efficient allocation of scarce resources in response to the competing wants and needs in the marketplace

  • Scarce resources are the factors of production (land, labour, capital, enterprise)

Private, Social & External Costs

• Externalities occur when there is an external impact on a third party not involved in the economic transaction between the buyer & seller

  • These impacts can be positive or negative & are often referred to as spillover effects

  • These impacts can be on the production side of the market (producer supply) or on the consumption side of the market (consumer demand)

• External costs occur when the social costs of an economic transaction are greater than the private costs

  • A private cost for the producer, consumer or government is what they actually pay to produce or consume a good/service e.g. a consumer pays $9 for a McDonald's meal

  • An external cost is the damage not factored into the market transaction e.g. the consumer throws their McDonalds packaging onto the street & the Government has to hire cleaners to collect the litter

• The social cost includes both the private cost & the cost to society

  • It is a better reflection of the true cost of an economic transaction

  • Social cost = private cost + external cost