2.8 Market Failure - Positive Externalities Flashcards
Define positive externalities of production:
“Spillover effects which benefit third parties from the production of a good”
Explain positive externalities of production in the DIG using the example of a new car factory opening in a town:
–> The opening of a new car factory benefits the firm but also society therefore the marginal social costs to society are lower than the marginal private costs and the difference between two curve is the positive externalities.
We assume there are no externalities associated with consumption, therefore D = MPB = MSB.
In the car factory example, the market equilibrium is at output Q, price P.
But the social optimum level of output is at the output Q opt, price P opt where MSC = MSB.
There is market failure in the industry as Qopt is greater than Q due to an under-allocation of resources.
Due to the under allocation of resources, there is a welfare loss (area ABC) because the marginal social benefits are greater than the marginal social costs at each level between Q and Qopt.
Define positive externalities of consumption:
“Positive spillover effects onto third parties not involved in the consumption of a good/service”
Explain positive externalities of consumption in the DIG using the example of a covid-19 vaccines:
–> The consumption of Covid-19 vaccines creates positive externalities (which are the positive spillover effects onto third parties not involved in the consumption of the Covid-19 vaccines)
In this market, the Marginal Private Benefits (MPB) of consumers (as the vaccines prevents catching the disease) are less than the Marginal Social Benefits (MSB), as it prevents the spread of the pandemic.
In this market, individuals consume the vaccines at quantity Q, price P whereas the social optimum level of output is at Qopt, price Popt; resulting in an under-consumption of Covid19 vaccines and too few resources are allocated in this market, causing market failure
MSB is greater than MPB between the output Q - Qopt. Because society wants a higher consumption of the vaccines than the consumers, there is a welfare loss to society (as shown by the are ABC on the diagram)
We assume that there are no production externalities and therefore S = MPC = MSC
What are merit goods?
Goods that create strong positive externalities
(eg. Healthcare, Education..)
Why are merit goods under-consumed?
Due to imperfect information
(often provided by the government)
How does the consumption of merit goods affect the PPC?
Deemed socially desirable –> positive externalities –> positive impact onto society –> improves quality of life
PPC shifts right, increase in quantity (and/or quality of goods)
Merit goods are consumed at a ____ quantity than what society would want
Merit goods are consumed at a “LOWER” quantity than what society would want
What are the two characteristics of merit goods?
- Rivalrous
- Excludable
What is “Rivalrous”?
- consumption of 1 merit good reduces the availability of that good for someone else (at that point in time)
- EG. There is a maximum number of students that can attend a school, so by attending you are reducing the available number of spots available
What is “Excludable”?
- It is possible to prevent non-payers of the good to consume the good
- EG. you do not pay the BSB fee, you can not attend the school
Why are merit goods underprovided?
As we assume producers to be profit-maximisers, they only want to produce goods with high profit margins, and not any merit goods because they are under-consumed. Therefore they are underprovided.
