A positive externality is a side benefit for people outside the deal. Buyers and sellers ignore it, so the free market makes too little of the good.
Two kinds of positive externality
Of consumption
Your vaccination protects people around you too.
Of production
A dam built for power also brings roads and jobs nearby.
Merit goods
Education and health care: people would use too little of them.
The points to remember
- The market stops where MPB = MPC; society wants MSB = MSC.
- With a positive externality, the market makes too little: a welfare loss.
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Start with consumption, the case papers ask about most.
Our example (made-up numbers)
| Private benefit | External benefit | Social benefit | |
|---|---|---|---|
| Each extra unit | MPB | + €4 | MSB = MPB + €4 |
| Output | Market: 40 | Optimum: 60 |
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Remember it as: A positive externality: the market stops too early.
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Production can have side benefits too: the cost to society is lower than the firm's own cost.
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Governments raise output to the optimum with a subsidy, by providing the good themselves, by rules such as compulsory schooling, or by information campaigns.
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The points to remember
- A subsidy or government provision shifts supply right to Qopt.
- Information campaigns raise MPB towards MSB.
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Paper 1 asked this in November 2022, as part (a) for 10 marks.
Explain why the existence of positive externalities of consumption would lead to allocative inefficiency and thus a welfare loss.
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What the diagram must show
- Axes: costs and benefits, Q; MPB, MSB above it, MPC = MSC.
- Qm (MPB = MPC) and Qopt (MSB = MSC); the welfare loss between them.
How the 10 marks are given
| Marks | What your answer needs |
|---|---|
| 9–10 | Theory fully explained, terms used correctly all the way through, the diagram included and fully explained |
| 7–8 | Theory explained, terms mostly right, the diagram included and explained |
| 5–6 | Theory partly explained, some terms, the diagram included |
| 1–4 | Theory only described or stated; few relevant terms |