Positive Externalities

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Positive Externalities

  1. 1. Positive ExternalitiesAS Microeconomics
  2. 2. 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
  3. 3. 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
  4. 4. Social benefits Where there are positive externalities the socialbenefit of production and/or consumptionexceeds the private benefit
  5. 5. 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
  6. 6. 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?
  7. 7. 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
  8. 8. Positive externalities and market failureOutputCostsandBenefitsMarginalPrivateBenefitMarginalPrivate Cost =MarginalSocial CostMarginalSocialBenefitQ2Q1ConsumerSurplusProducer SurplusEquilibrium output
  9. 9. Positive externalities and market failureOutputCostsandBenefitsMarginalPrivateBenefitMarginalPrivate Cost =MarginalSocial CostMarginalSocialBenefitQ2Q1ConsumerSurplusProducer SurplusEquilibrium outputGain tootherpeople
  10. 10. Positive externalities and market failureOutputCostsandBenefitsMarginalPrivateBenefitMarginalPrivate Cost =MarginalSocial CostMarginalSocialBenefitQ2Q1In a free marketconsumption will be at Q1because Demand = Supply(private benefit = privatecost )
  11. 11. Positive externalities and market failureOutputCostsandBenefitsMarginalPrivateBenefitMarginalPrivate Cost =MarginalSocial CostMarginalSocialBenefitQ2Q1However this is sociallyinefficient because SocialCost < Social Benefit.Therefore there is underconsumption of thepositive externality
  12. 12. Positive externalities and market failureOutputCostsandBenefitsMarginalPrivateBenefitMarginalPrivate Cost =MarginalSocial CostMarginalSocialBenefitQ2Q1Social Efficiency wouldoccur at Q2 where SocialMarginal Cost = SocialMarginal Benefit
  13. 13. 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
  14. 14. Encouraging supply to reap social returns
  15. 15. 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
  16. 16. 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
  17. 17. 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
  18. 18. Tutor2uKeep up-to-date with economics,resources, quizzes andworksheets for your economicscourse.

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