Editing Marginal cost (section)

== Private versus social marginal cost ==
{{main|Social cost}}
Of great importance in the theory of marginal cost is the distinction between the marginal ''private'' and ''social'' costs. The marginal private cost shows the cost borne by the firm in question. It is the marginal private cost that is used by business decision makers in their [[profit maximization]] behavior. Marginal social cost is similar to private cost in that it includes the cost of private enterprise but ''also'' any other cost (or offsetting benefit) to parties having no direct association with purchase or sale of the product. It incorporates all negative and positive [[externalities]], of both production and consumption. Examples include a social cost from air pollution affecting third parties and a social benefit from flu shots protecting others from infection.

Externalities are costs (or benefits) that are not borne by the parties to the economic [[Financial transaction|transaction]]. A producer may, for example, [[pollution|pollute]] the environment, and others may bear those costs. A consumer may consume a good which produces benefits for society, such as education; because the individual does not receive all of the benefits, he may consume less than efficiency would suggest. Alternatively, an individual may be a smoker or alcoholic and impose costs on others. In these cases, production or consumption of the good in question may differ from the optimum level.

=== Negative externalities of production ===
[[Image:NegativeExt.svg|thumb|right|Negative Externalities of Production]]

Much of the time, private and social costs do not diverge from one another, but at times social costs may be either greater or less than private costs. When the marginal social cost of production is greater than that of the private cost function, there is a [[negative externality]] of production. Productive processes that result in [[pollution]] or other environmental waste are textbook examples of production that creates negative externalities.

Such externalities are a result of firms externalizing their costs onto a third party in order to reduce their own total cost. As a result of externalizing such costs, we see that members of society who are not included in the firm will be negatively affected by such behavior of the firm. In this case, an increased cost of production in society creates a social cost curve that depicts a greater cost than the private cost curve.

In an equilibrium state, markets creating negative externalities of production will overproduce that good. As a result, the socially optimal production level would be lower than that observed.

=== Positive externalities of production ===
[[Image:PositiveExt.svg|thumb|right|Positive Externalities of Production]]

When the marginal social cost of production is less than that of the private cost function, there is a [[positive externality]] of production. Production of [[Public good (economics)|public good]]s is a textbook example of production that creates positive externalities. An example of such a public good, which creates a divergence in social and private costs, is the production of [[education]]. It is often seen that education is a positive for any whole society, as well as a positive for those directly involved in the market.

Such production creates a social cost curve that is below the private cost curve. In an equilibrium state, markets creating positive externalities of production will underproduce their good. As a result, the socially optimal production level would be greater than that observed.