A quick recap on externalities An externality exists when the action of oneagent unavoidably affects the welfare of anotheragent. The affected agent may be a consumer, givingrise to a consumption externality, or a producer,giving rise to a production externality
What are positive externalities? Positive externalities create benefits to third parties Activities said to generate positive externalitiesinclude: Social returns from investment in education & training Benefits from high quality public service broadcasting Positive benefits from health care and medicalresearch Benefits from vaccination and immunizationprogrammes Flood protection systems & fire safety equipment Restored historic buildings and monuments Social benefits from protecting environmentalresources
Social benefits Where there are positive externalities the socialbenefit of production and/or consumptionexceeds the private benefit
Social benefits explainedPrivateBenefits+ External benefits = SocialBenefitsBenefits toindividualconsumers orfirms of theireconomicactivityBenefits to others ofindividualconsumers or firmseconomic activityTotal benefits tosociety of agiven economicactivityBenefits tofirst parties -individualsBenefits to thirdparties - othersTotal benefitsto society –everyone
Positive spill-oversFlood protection schemes,immunization and galleries andmuseums all provide externalbenefitsLeft to itself, would the free-market fail to provide sufficientproducts that yield positiveexternalities?
Positive externalities from educationand training Improved social skills and awareness of citizenship Greater long-term contribution to the economy Higher productivity Diffusion of knowledge and understanding Improved employability / reduced risk of structuralunemployment Impact on international competitiveness from animprovement in human capital All of the above should help to contribute to a highertrend rate of growth Higher expected earnings might provide increasedtax revenues for the government
Positive externalities and market failureOutputCostsandBenefitsMarginalPrivateBenefitMarginalPrivate Cost =MarginalSocial CostMarginalSocialBenefitQ2Q1In a free marketconsumption will be at Q1because Demand = Supply(private benefit = privatecost )
Positive externalities and market failureOutputCostsandBenefitsMarginalPrivateBenefitMarginalPrivate Cost =MarginalSocial CostMarginalSocialBenefitQ2Q1However this is sociallyinefficient because SocialCost < Social Benefit.Therefore there is underconsumption of thepositive externality
Positive externalities and market failureOutputCostsandBenefitsMarginalPrivateBenefitMarginalPrivate Cost =MarginalSocial CostMarginalSocialBenefitQ2Q1Social Efficiency wouldoccur at Q2 where SocialMarginal Cost = SocialMarginal Benefit
Positive externalities and market failureOutputCostsandBenefitsMarginalPrivateBenefitMarginalPrivate Cost =MarginalSocial CostMarginalSocialBenefitQ2Q1Welfare loss fromthe good beingunder-consumedUnder-consumption ofproducts with positiveexternalities leads to a netloss of social welfare –shown in the diagram above
Government intervention options Government subsidy either to producer or consumer Reduce private cost of consumption or reduce cost of supply Lower costs should cause an expansion of demand E.g. Student grants and low-cost loans? Subsidies to fund free entrance to museums and heritagesites Providing free vaccines at the point of use Command and Control techniques Minimum school leaving age Compulsory health immunisation programmes Improved information flows to potential consumers Health awareness programmes Goods with positive externalities are often public goods –e.g. Investment in reduction programmes for communicablediseases
A subsidy to the producerOutputCostsandBenefitsMPBMPC=MSCMSBQ2Q1Welfare loss fromthe good beingunder-consumedA producer subsidy wouldcut the marginal cost ofsupplying to the consumer –a lower price would bringabout an expansion ofdemand towards the sociallyoptimal levelMPC withsubsidy
Evaluation points Often difficult to identify the positive externalitiesand then put a market value on them People/organisations may have an incentive toover-estimate the spill-over benefits whenlobbying for financial assistance Providing services ‘free at the point’ of need maycause over-consumption Subsidies always carry an opportunity cost Regulation consumption involves a cost too
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