True Cost Economics: What It Is and How It Works

What Is True Cost Economics?

True cost economics is a model that includes the cost of negative externalities in the pricing of goods and services. Proponents believe that products and activities causing harmful consequences to living beings and/or the environment should be taxed to reflect their hidden costs.

Key Takeaways

• True cost economics includes the cost of negative externalities.
• Negative externalities are costs imposed on others by the use of a good or service.
• Common negative externalities include pollution from cars or second-hand smoke.
• True cost economics seeks to impose a tax on negative externalities.

Understanding True Cost Economics

True cost economics is often applied to the production of commodities and represents the difference between the market price and the total societal cost, such as the impact on the environment or public health. The concept also applies to positive externalities, like the pollination of plants by bees benefiting the environment at no cost.

True Cost Economics Theory

True cost economics arises from the need for ethical consideration in neoclassical economic theory. It suggests that the societal cost of producing a product or service is not accurately reflected in its price.

For example, taxpayers bear the healthcare costs of smokers rather than cigarette manufacturers.

Under true cost economics, a third party may impose a tariff or tax to influence consumer behavior and provide means for future remediation when production, rendering, or impact costs are not reflected in the price.

This action would force companies to "internalize" negative externalities, resulting in higher market prices.

For instance, a government can regulate the pollution emitted by companies or impose taxes on carbon dioxide emissions to correct market inefficiency.

True Cost Economics and Consumers

Accounting for the true costs of many goods and services could significantly increase their prices that are currently affordable and taken for granted. For example, factoring in the environmental costs of extracting and refining rare earth elements may make them unaffordable.

If the air, noise, and other pollution caused by manufacturing and using a new car were considered, its price would significantly rise.

What Is the True Price Theory?

The true price theory is the market cost plus the true costs of an item. It reflects internal and external costs and should be the price consumers pay, rather than just the market price.

What Are the 4 Externalities in Economics?

The four general externalities in economics are positive production, positive consumption, negative production, and negative consumption. Production externalities result from the producers’ actions, while consumption externalities are generated by consumers.

What Is an Example of a True Cost?

An example of a true cost is the healthcare costs associated with treating drug users. The companies that create the drugs causing these issues do not bear the costs of damages.

The Bottom Line

True cost economics determines the true cost of goods or services by including the cost of negative externalities and the negative effects on people and the environment. Proponents believe that implementing a tax to cover negative externalities would benefit society.

True cost economics determines the true cost of goods or services by including the cost of negative externalities and the negative effects on people and the environment. Proponents believe that implementing a tax to cover negative externalities would benefit society.