Unit 5 | Regulations - Cost Benefit analysis

Cost Benefit Analysis is typically used by governments to evaluate the desirability of a given intervention in markets. The costs and benefits of the impacts of an intervention are evaluated in terms of the social benefits or social cost. The guiding principle is to list all of the parties affected by an intervention, and place a monetary value of the effect it has on their welfare.

Private cost - It is the cost of setting up the business. The owner(s) pay for the hire of machinery, buying of materials, payments of wages.
Private benefit - The monetary benefits i.e. the revenue earned by the firm is a benefit for the owner.

External Cost - The problems that the external stakeholders have to bear due to the firm’s activity are known as external cost. Example: cleaning a river which has been polluted by a firm’s waste products. Private firms usually ignore external cost.

External benefits - Some firms can cause external benefits. These are the benefits to the external stakeholders due to the activity of firm. For example, a firm may train workers, which might get them better wages in other firms. These external benefits are free.

Social cost - the total cost paid for by the society due to the activities of a firm. It is the sum of all the external cost and private cost.

Social benefit - the total benefit arising due to the production of goods and services by a firm. This is equal to the total of private benefits and external benefits.

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