Cost/benefit analysis, or CBA, involves calculating the costs and benefits of a particular action, project or production to see if it should go ahead. This involves considering the monetary value of the costs and benefits. However, these cannot always be quantified - it's hard to place a value on pollution or inconvienience. This is the major criticism of cost/benefit analysis.

Private costs are costs which the business has to pay. These are not just costs incurred by the company, but also costs incurred by its customers.

External costsor negative externalities are any costs borne by anyone other than the company or its customers, such as the immediate local community or society as a whole.

External costs + Private costs = Social costs. This is the genuine social cost of the action, project or decision.

Private benefits are benefits enjoyed by the company or its customers.

External benefits, or positive externalities are benefits enjoyed by anyone other than the business or its customers, ie society.

Private benefits + External benefits = Social benefits, the genuine total benefit of a particular action.

Internalising

Businesses try to minimise their own external costs by ignoring the damage they do to the environment or community. Someone else is paying for these costs.

However, of late, two things have happened. Businesses have realised that if they try to minimise the damage they do to the environment and the community, stakeholders will look on them a lot more favourably. Groups such as the government, customers and pressure groups might back up a bit.

The other thing that has happened is that the government has passed legislation to make businesses more responsible for the damage they inflict. The introduction of the catalytic converter is an example of this.

Wherever external costs are turned into private costs in either of the manners described above, the process is known as internalising. In the eyes of the local community, a business which internalises enough has a licence to operate.