Unit 1 Micro: Positive Externalities

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There are many occasions when the production and/or consumption of a good or a service creates external benefits which boost social welfare.

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  • The existence of production and consumption externalities creates a divergence between either the private and social costs of production or the private and social benefits of consumption.
  • External benefits are the benefits of positive externalities expressed in terms of money
  • A well educated labour force is more flexible & productive thereby and so less likely to be unemployed. Training workers similarly increases human capital, improving the supply side of the economy and international competitiveness. But will businesses invest in enough training if there is a risk that their workers will leave?
  • With positive externalities, there are external benefits from production and/or consumption – as a result, the socially efficient output is greater than current output
  • Market failure also occurs when firms ignore the positive external effects of their production.
    The demand curve is a measure of private benefit. Adding positive externalities to D gives social benefit. SB = PB + EB.
    The equilibrium level of output delivered by a free market is allocatively inefficient. SMB = SMC at Qs. The market has under produced The welfare loss triangle ABC quantifies the amount of welfare loss resulting from underproduction
  • Positive externalities cause mean social benefits exceed private costs resulting in underproduction, therefore there is a case for some form of government intervention designed to increase production and consumption of activities that lead to positive externalities.
  • Unit 1 Micro: Positive Externalities

    1. 1. Positive Externalities AS Economics
    2. 2. Positive Externalities • Positive externalities create external benefits to 3rd parties • Activities said to generate positive externalities include: – Social returns from investment in education & training – Positive benefits from health care and medical research – Benefits from vaccination and immunization programmes – Provision of flood protection systems & fire safety equipment – Restored historic buildings and monuments – External benefits from usage of public libraries and museums – Externalities from inward migration of population • Population diversity • More innovation
    3. 3. Social benefits defined • Social benefits refer to the total benefit to society from a good ie the benefit to individuals and any beneficial unintended spill over effects on third parties. • Social benefits are found by adding together the private and external benefits of a given economic activity.
    4. 4. Social benefits Private Benefits + External benefits = Social Benefits Benefits to individual consumers or firms of their economic activity Benefits to others of individual consumers or firms economic activity Total benefits to society of a given economic activity Benefits to first parties - individuals Benefits to third parties - others Total benefits to society – everyone
    5. 5. Positive Externalities Flood protection schemes, immunization and galleries and museums all provide external benefits Left to itself, would the free- market fail to provide sufficient products that yield positive externalities?
    6. 6. Positive Externalities – the key points • With positive externalities the social benefit > private benefit • Individual consumers may under-value and under- consume these goods and services • The under-valuation of the private benefit of consuming a product may be as a result of imperfect information • Under consumption / under provision leads to market failure
    7. 7. Social Benefits from Education & Training • Improved social skills and awareness of citizenship • Greater long-term contribution to the economy – Higher productivity – Improved employability – Impact on competitiveness from an improvement in human capital – All of the above should help to contribute to a higher trend rate of growth • Higher expected earnings might provide increased tax revenues for the government • Diffusion of knowledge and understanding
    8. 8. Vaccinations • Outline some of the private benefits to people from a vaccination programme (for example a programme run in a developing country) • Outline some of the possible external benefits from this programme – Short term external benefits – Longer-term external benefits
    9. 9. Externalities: Problems of measurement • Many positive externalities are intangible – Human relationships – Cultural awareness • Normative values are involved • However - some external benefits can be measured – Productivity effects – Employment effects – Health outcomes
    10. 10. Positive Externalities & Social Welfare Costs Benefits Output (Q) Private Benefit PC = SC Qp
    11. 11. Positive Externalities & Social Welfare Costs Benefits Output (Q) PB PC = SC SB Qp Assume consumption of a good generates positive externalities
    12. 12. Positive Externalities & Social Welfare Costs Benefits Output (Q) PB PC = SC SB Qp Qs
    13. 13. Positive Externalities & Social Welfare Costs Benefits Output (Q) PB PC = SC SB Qp Qs
    14. 14. Positive Externalities & Social Welfare Costs Benefits Output (Q) PB PC = SC SB Qp Qs External Benefit
    15. 15. Positive Externalities & Social Welfare Costs Benefits Output (Q) PB PC = SC SB Qp Qs External Benefit Under-provided
    16. 16. Positive Externalities & Social Welfare Costs Benefits Output (Q) PB PC = SC SB Qp Qs External Benefit Loss of economic welfare
    17. 17. Positive externalities – correcting for market failure • Positive externalities cause mean social benefits exceed private costs resulting in underproduction, • There is a case for some form of government intervention designed to increase production and consumption of activities that lead to positive externalities. • The issue is which form of intervention is most efficient and most equitable in achieving the desired social optimum level of production.
    18. 18. Encouraging supply and consumption
    19. 19. Encouraging Consumption / Provision • Government subsidy – Designed to reduce the private cost of consumption or reduce the cost of supply – Lower costs should cause an expansion of demand • Student grants and low-cost loans? • Subsidies to fund free entrance to museums and other heritage sites • Command and Control techniques • Minimum school leaving age • Compulsory health immunisation programmes • Improved information flows to potential consumers • Health awareness programmes
    20. 20. Free entry to museums – the arguments Is there a strong economic case for the government subsidising free entry to our major museums?
    21. 21. Economic arguments • Case for subsidy / free entry • Counter arguments
    22. 22. Economic arguments • Case for subsidy / free entry • Positive externalities • Informational benefits • More visitors – higher non- entrance fee revenues • Boost to British tourism
    23. 23. Counter arguments • Which museums should be free? • Risk of dependency on the subsidy? • Do people value things as much when they are free? • Diminishing returns? • Low Ped – requires expensive subsidy to boost numbers • Opportunity cost of the money used

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