8/29/2017 Positive Externalities | Economics Help

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Positive Externalities

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De nition of Positive Externality: This occurs when the consumption or production of a good causes a bene t to a third party. For
example:

When you consume education you get a private bene t. But there are also bene ts to the rest of society. E.g you are able to educate
other people and therefore they bene t as a result of your education. (positive consumption externality)
A farmer who grows apple trees provides a bene t to a beekeeper. The beekeeper gets a good source of nectar to help make more
honey. (positive production externality)
If you walk to work, it will reduce congestion and pollution; this will bene t everyone else in the city.

Social Bene t

With positive externalities, the bene t to society is greater than your personal bene t.

Therefore with a positive externality the Social Bene t > Private Bene t

Remember Social Bene t = private bene t + external bene t.

Diagram of Positive Externality (consumption)

In this case, the social marginal bene t of consumption is greater than the private marginal bene t. For example, if you take a train, it
reduces congestion for other travellers.
In a free market, consumption will be at Q1 because demand = supply (private bene t = private cost )
However, this is socially ine cient because at Q1, social marginal cost < social marginal bene t. Therefore there is under-consumption
of the positive externality.
Social e ciency would occur at Q2 where social cost = social bene t

For example, in a free market without government intervention, there would be under-consumption of education and public transport.
Positive externality (production)
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8/29/2017 Positive Externalities | Economics Help

Positive externality (production)

This occurs when a third party bene ts from the production of a good. For example, building a train station may provide shelter for the
homeless when it is raining.
If a company develops new technology, such as a database programme, this new technology can be implemented by other rms who
will gain a similar boost to productivity.
Tim Berners Lee who developed the World Wide Web, made it freely available, creating a very large positive externality.

Diagram of positive externality in production

(http://www.economicshelp.org/wp-content/uploads/2012/11/positive-externality-in-production.jpg)

Because there are positive externalities in production, the social marginal cost of production is less than the private marginal cost of
production.
In a free market, a rm will ignore bene ts to third parties and will produce at Q1 (free market outcome)
However, the socially e cient level will be at Q2 (where social marginal cost = social marginal bene t)

Dealing with positive externalities

Positive externalities lead to under-consumption and market failure. Government policies to increase demand for goods with positive
externalities include

1. Rules and regulations minimum school leaving age

2. Increasing supply government building of council housing to increase stock of good quality housing.
3. Subsidy to reduce price and encourage consumption, e.g. government subsidy for rural train services.

Diagram to show e ect of subsidy on good with positive externalities

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(http://www.economicshelp.org/wp-content/uploads/2012/11/subsidy-positive-externality.png)

A subsidy of P0-P2 shifts supply curve to the right (S2) and the new quantity demand will be Q2 (where SMB=SMC)

In this case the subsidy has overcome the market failure. Though government intervention itself could be subject to government failure.

more detail at: Subsidy on positive externality (https://www.economicshelp.org/marketfailure/subsidy-positive-ext.html)

Which diagram to draw?

Either (production or consumption externality) is acceptable to show the principle of positive externalities. Generally, I advise using the
positive externalities of consumption. To simply economics for some students (who often get confused by these diagrams), I will only teach
one positive externality diagram. (consumption)

Related

Positive externalities in the housing market (https://www.economicshelp.org/blog/9207/housing/external-bene ts-housing-market/)

examples of positive externalities in the housing market, such as improved local communities, improved public health and better
environmental standards.
Subsidy on positive externality (https://www.economicshelp.org/marketfailure/subsidy-positive-ext.html)
Negative externality (https://www.economicshelp.org/micro-economic-essays/marketfailure/negative-externality/)
Should we pay to see the doctor? (http://econ.economicshelp.org/2008/09/should-we-pay-to-see-doctor.html)

Last updated: 10th July 2017, Tejvan Pettinger (http://www.economicshelp.org/about-2/), www.economicshelp.org, Oxford, UK

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