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 2 asked this in May 2025, for 4 marks, in all three time zones (education, sanitation, health care).
Using an externalities diagram, explain how increased government investment in education could achieve allocative efficiency in a country's education market.
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What the diagram must show
- Axes: costs and benefits, Q; D = MPB, MSB above it, S = MPC = MSC.
- Qm and Qopt; the welfare loss; and the shift of supply (or MPB) taking output to Qopt.
How the 4 marks are given
| Marks | What your answer needs |
|---|---|
| 3–4 | A correct diagram and a correct explanation |
| 1–2 | A correct diagram or a correct explanation, not both |
| 3 at most | A diagram with a wrong or missing label |