Pollution becomes an expense when the result of an activity causes damage to someone else. When producing goods, a factory can inflict cost on a population if it doesn’t take on accountability for polluting.
To make it easier to understand, let’s look at several examples. When someone smokes, he pollutes the air in a specific area. If a non-smoker stays within that area, they might be affected. That person could have health problems due to second-hand smoke. They might have to consult a doctor and buy medicine for treatment. If they miss work because of health problems, their employer will suffer a loss in productivity during the absence.
The money used to buy medicine and the money lost due to the missed days are called external costs, provoked by the smoke. The profits made by selling cigarettes are concentrated on the company only and the rest of the population has to pay for the damages. The smoker, whom we can easily blame in this example, should pay the extra cost when buying cigarettes. This is one of the reasons smokers are heavily taxed today.
As another example, a factory may pollute a river during production. If that river is a very lucrative tourist attraction for local businesses, which involves swimming, fishing, restaurants, etc., the municipality will lose important revenue if it becomes polluted. In addition, the population would have to pay in order to clean the water and repair all other damages.
We call this external cost because the factory doesn’t take into account the damages incurred by the production of its goods. It concentrates only on the private costs, including machinery, equipment, and employees. The local municipality, however, does assume the cost of pollution. We combine the private cost and the external cost in order to calculate the social cost.
Noise pollution also enters into that category; houses situated close to an airport are always cheaper because of the noise created by airplanes. This becomes a cost for the resident. This principle can be applied on a much larger scale in terms of transport activities. The driving of a vehicle inflicts external costs to the whole world by adding to the rising problem of Global Warming.