Positive externalities in Consumption & Production Flashcards
(29 cards)
What is a positive externality in consumption?
A benefit to third parties as a result of a consumer’s actions, which is not reflected in market prices.
Give three examples of positive externalities in consumption.
Vaccination – reduces disease spread, protecting others.
Education – raises productivity, tax revenue, and civic engagement.
Exercise – lowers healthcare costs, improves worker productivity.
Who are third parties in positive consumption externalities?
Individuals or economic agents not directly involved in the transaction but who benefit from it (e.g., employers, the NHS, wider society).
How is a positive externality in consumption shown on a diagram?
MSB > MPB
The MSB curve lies above the MPB curve
The market equilibrium is at MPB = MPC
The socially optimal output is at MSB = MPC
The gap between them shows underconsumption
What causes the market to underprovide goods with positive externalities?
Consumers only consider private benefits, ignoring external benefits, leading to underconsumption and market failure.
What is the welfare loss in the case of positive consumption externalities?
A triangle area between MPB and MSB, representing lost potential welfare due to underconsumption.
What does MSB = MPB + EB mean?
Marginal Social Benefit equals Marginal Private Benefit plus any External Benefit from the good or service.
What happens to the supply curve (MSC = MPC) when there are positive consumption externalities?
It stays the same — no impact on production costs, so the supply curve remains unchanged.
How is a positive consumption externality shown on a diagram?
MSB > MPB
The MSB curve lies above the MPB (demand) curve
Free market equilibrium: MPB = MPC at price P₁ and quantity Q₁
Social optimum: MSB = MPC at price P* and quantity Q*
The gap indicates underconsumption
Why does the market underprovide goods with positive consumption externalities?
Because individuals ignore the external benefits, they consume at the private optimum (Q₁), not the social optimum (Q*).
What does the welfare loss triangle represent in this diagram?
The missed social benefit from underconsumption — society loses out because fewer units are consumed than is socially desirable.
When does welfare loss occur in this context?
When social benefit > social cost, but the good isn’t consumed — the loss is the benefit society would have gained from those extra units.
How can this be evaluated in analysis?
You can say consumers act in self-interest, considering only private benefits, so the market fails to deliver the socially optimal quantity — leading to allocative inefficiency and welfare loss.
What is a positive externality in production?
A benefit to third parties resulting from the production activities of a firm, not reflected in the market price.
Give two examples of positive production externalities.
Workplace training – firms that didn’t pay for training can hire skilled workers.
R&D (Research and Development) – other firms benefit from shared or copied innovations without paying the full cost.
Why does the supply curve shift with positive production externalities?
Because external benefits reduce the true social cost, so the MSC curve lies below the MPC curve.
How is a positive externality in production shown on a diagram?
MSC < MPC
Free market produces where MPC = MPB, at quantity Q₁
Social optimum is where MSC = MPB, at higher quantity Q*
This leads to underproduction
What causes welfare loss in the case of positive production externalities?
Because less is produced than is socially desirable, society misses out on the extra benefits from increased output.
How do external benefits lead to market failure in this case?
Producers only consider private costs, not the social benefit to others, leading to underproduction and allocative inefficiency.
What does the welfare loss triangle represent in this context?
The net social benefit forgone due to underproduction — the triangle between MSC and MPC from Q₁ to Q*.
What is the market failure here caused by?
Self-interest — firms focus on private costs and benefits, ignoring how their production positively affects others.
What happens when there is underproduction due to positive externalities?
he market allocates resources at the private optimum (P₁, Q₁) rather than the social optimum (P, Q), leading to underproduction and a welfare loss.
How do producers ignore external benefits?
Producers focus only on private costs and ignore external benefits to third parties. This is due to self-interest, resulting in production levels below the social optimum.
What is the impact of underproduction on society?
Underproduction leads to a misallocation of resources and allocative inefficiency, causing a welfare loss — society misses out on the additional benefits from extra production.
