What is True Cost Economics?

True cost economics is an economic model that seeks to include the cost of negative externalities into the pricing of goods and services. Proponents of this type of economic system feel products and activities that directly or indirectly cause harmful consequences to living beings and/or the environment should be taxed accordingly to reflect their hidden costs.

Understanding True Cost Economics

True cost economics are most often applied to the production of commodities and represents the difference between the market price of a commodity and total societal cost of that commodity, such as how it may negatively affect the environment or public health (negative externalities). The concept also may be applied to unseen benefits — otherwise known as positive externalities — such as how the pollination of plants by bees has an overall positive effect on the environment at no cost.

True Cost Economics Theory

The school of thought behind true cost economics comes as a result of the perceived need for ethical consideration in neoclassical economic theory. The thinking behind true cost economics is based on the belief that the societal cost of producing a product or rendering a service may not be accurately reflected in its price. For an example of a societal cost, consider the extra burden to taxpayers, consumers and the government of providing health care for smokers — a cost not at all borne by cigarette manufacturers.

When the price of something fails to reflect all the total costs associated with its production, rendering or impact, then under true cost economics a third-party (a regulator or government) may have the obligation to step in to impose a tariff or tax to influence consumer behavior and/or provide the means for future remediation. Such an action would involve forcing companies to "internalize" the negative externalities. This would invariably cause market prices to increase.

An example of such a practice is when a government regulates the amount of pollution a company is allowed to create and release, such as with the coal industry and mercury and sulfur emissions. Negative externalities may also be taxed, such as carbon dioxide emissions. Such a tax is known as a Pigovian tax, which is defined as any tax that seeks to correct an inefficient market outcome.

True Cost Economics and Consumers

For consumers, the cost of many goods and services that are currently affordable, and often taken for granted, could see an extreme rise in costs if their "true costs" are accounted for. For example, if the environmental cost of extracting and refining the rare earth elements that are essential for many modern electrical products were factored into their price, it might push that price to an unreachable sum. And if one accounted for air, noise and other types of pollution caused by the manufacturing and the use of a new car, then the price of the new car would, by some estimates, increase by over $40,000.