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social coststhe COSTS borne by society resulting from the actions of FIRMS. Consider, for example, a river that is used by both a chemical firm to dispose of its waste and by a town as a source of drinking water. Assume that the continuous dumping of waste causes the river to become polluted. The firm incurs PRIVATE COSTS in producing chemicals but pays out nothing for the use of the river or the POLLUTION caused. The town, by contrast, is forced to install special water-treatment plants to counter the pollution. Thus, the extra cost of cleaning up the river is not borne by the firm but by society
One way to remedy this divergence of private and social costs is to tax the firm an amount equivalent to the costs of treating the pollution. Making the firm pay the full costs of supplying chemicals has the merit of encouraging it to look around for the least costly way of disposing of its waste; that is, instead of dumping its waste in the river it might be cheaper for the firm to invest in a waste disposal plant. See also MARKET FAILURE, EXTERNALITIES, WELFARE ECONOMICS, COST-BENEFITS ANALYSIS, POLLUTER PAYS PRINCIPLE.