Economics 9708/32 — May/June 2017

Background Concept

An economic activity generates both private benefits (received by the person or firm undertaking it) and external benefits (received by third parties who are not directly involved in the activity). Similarly, it imposes both private costs (borne by the person or firm) and external costs (borne by third parties). The sum of private and external benefits is the total social benefit (TSB), and the sum of private and external costs is the total social cost (TSC). Net social benefit is the difference: TSB – TSC. If this difference is positive, the activity creates a net benefit for society overall; if negative, it creates a net cost.

Understanding the Question

The question asks for the condition under which an economic activity yields a net social benefit. It presents four algebraic expressions and asks which one, when positive or negative, indicates a net social benefit. This is a fundamental definitional question from the topic of externalities.

Approach

1. Recall the definition of net social benefit as the difference between total social benefit and total social cost.
2. Write the expression for total social benefit: private benefit + external benefit.
3. Write the expression for total social cost: private cost + external cost.
4. Form the difference: (private benefit + external benefit) – (private cost + external cost).
5. Identify the sign of the difference that represents a net benefit: positive.
6. Match this to the options.

Step-by-Step Reasoning

• Step 1: Define total social benefit (TSB). It includes everything that is gained from the activity, whether by the decision-maker or by others. TSB = private benefit + external benefit.
• Step 2: Define total social cost (TSC). It includes all the costs incurred, whether by the decision-maker or by others. TSC = private cost + external cost.
• Step 3: Define net social benefit. It is a measure of whether the activity adds value to society on balance. Net social benefit = TSB – TSC = (private benefit + external benefit) – (private cost + external cost).
• Step 4: Interpret the sign. If the result is positive, the benefits outweigh the costs, so the activity creates a net social benefit. If the result is negative, the costs outweigh the benefits, so the activity creates a net social cost.
• Step 5: Examine the options:
  • Option A: TSB – TSC is negative → net social cost, not benefit. Wrong sign.
  • Option B: TSB – TSC is positive → net social benefit. This is correct.
  • Option C: (private benefit + private cost) – (external benefit + external cost) is negative. This expression does not correspond to net social benefit; it subtracts externalities from private costs and benefits. It has no standard economic meaning.
  • Option D: Same incorrect expression as C but positive. Also incorrect.
• Conclusion: Option B is the correct answer.

Key Takeaways

• Net social benefit is the difference between total social benefit and total social cost.
• The condition for an activity to be socially beneficial is that total social benefit exceeds total social cost.
• The algebraic expression is (private benefit + external benefit) – (private cost + external cost) > 0.
• This is a core definition when analyzing externalities and social welfare.

Common Mistakes

• Confusing the order of subtraction: some students might incorrectly think net social benefit = social cost – social benefit. The sign matters.
• Mis-matching terms: plugging private costs where benefits should go, as in options C and D, is a common sign that the definitions are not clearly understood.
• Forgetting that externalities affect both the benefit and cost sides. Third-party effects are part of both the social benefit and social cost calculations.

Things to Be Careful About

• Read the expressions literally: each option combines different terms, so track which parts of the formula are included.
• Distinguish between 'social benefit' and 'social cost' as sums, not single magnitudes.
• The phrase 'create a net social benefit' means the net value is positive (benefits exceed costs), not negative.
• Do not be fooled by options that look plausible but use the wrong sign or the wrong combination of terms.