A Level Economics AQA Practice Exam

What do social costs encompass in an economic activity?

1. Only the private costs incurred by individuals

2. Private costs plus external costs

3. Only the external costs associated with production

4. Only the benefits accrued from the activity

The correct answer is: Private costs plus external costs

Social costs represent the total costs of an economic activity, which include both the private costs incurred by individuals or firms and the external costs that affect third parties who are not directly involved in the transaction. Private costs are the costs borne directly by the participants in the economic activity, such as production costs for a manufacturer or consumption costs for a consumer. External costs, on the other hand, account for the negative impacts that the activity imposes on others—like pollution resulting from production that affects nearby residents or ecosystems. By considering both these components, social costs provide a comprehensive view of an activity's true economic impact on society. This understanding is crucial for policy-making, especially when assessing the justification for interventions aimed at reducing negative externalities and promoting overall welfare.