A2.03.03: Positive Externalities

Question 1

3 examples of positive externalities in consumption and the third party effected

Answer 1

• Healthcare: 3rd party is other people having less risk of getting the flu
• Education: 3rd party is society benefiting as employees are likely to be more productive, have higher incomes and thus, pay greater taxes to governments which can lead to governments paying for more socially desirable assets like roads, schools etc
• Exercise: 3rd party are employers benefiting as workers will be able to work more often thus, producing more resulting in greater profits

Question 2

Define what positive externalities in consumption are

Answer 2

Benefits directly affecting economic agents as a result of the actions of consumers

Question 3

formula for social benefits

Answer 3

SB = PB + EB

Question 4

How does the graph of positive externalities in consumption look

Answer 4

• MSB > MPB

Question 5

Highlight the theory behind positive externalities in consumption

Answer 5

• individual consumers ignore the full social benefit of their actions and only consider their private benefits because of self-interest
• Thus, the market allocates resources at the private optimum meaning there is an underconsumption and underproduction of these resources
• This results in a misallocation of resources shown by the difference in the quantities Q1 and Q2, allocative inefficiency and deadweight loss

Question 6

Define what positive externalities in production are

Answer 6

Benefits directly affecting economic agents as a result of the actions of producers

Question 7

2 examples of positive externalities in production and the third party

Answer 7

• In-work training schemes: 3rd party are other firms benefiting without having to offer in-work training schemes themselves thus, benefitting from lower costs of production
• Research and Development: 3rd party are other firms that are able to copy the technology without having to spend large amounts of money on R&D thus, lowering their costs of production

Question 8

How does the graph of positive externalities in production look

Answer 8

MSC < MPC

Question 9

Highlight the theory behind positive externalities in production

Answer 9

• Individual firms only consider their private costs and not their full social costs thus, ignoring external benefits to third party firms and only occurs because of self interest
• Thus, the market allocates resources at the private optimum instead of the social optimum which means there is an under-production and under-consumption of these resources
• Therefore, resulting in misallocation of resources shown by the difference in the quantities Q1 and Q2, allocative inefficiency and deadweight loss

Question 10

What does the deadweight loss represent in the diagram for positive externalities in production and consumption and what does it explain

Answer 10

• Deadweight loss is equal to the difference between MSB and MSC for the amount of output that is underproduced relative to the social optimum
• This is a deadweight loss as it involves the EB for society that is lost as not enough of the good is produced
• If the externality was corrected, society would gain the benefits represented by the shaded area

Question 11

What does the deadweight loss represent in the diagram for negative externalities in production and consumption and what does it explain

Answer 11

• Deadweight loss is equal to the difference between MSB and MSC for the amount of output that is overproduced relative to the social optimum
• This is a deadweight loss as it involves the EC for society that is gained as too much of the good is produced
• If the externality was corrected, society would not suffer the costs represented by the shaded area

Question 12

with positive externalities is there an over or under-consumption/production of goods and services

Answer 12

• Underconsumption and underproduction of goods and services

Question 13

what is true about all externalities in production (what does it affect, costs or benefits)

Answer 13

• Costs

Question 14

Which side is the area showing the dead-weight loss pointing to the social optimum in positive externalities

Answer 14

• Left side

Question 15

How to structure answer when explaining diagram

Answer 15

• example
• 3rd party affected
• where price and quantity should be (optimum)
• where the curves lie
• deadweight loss occurs and its effects
• what would happen when externality is corrected

Question 16

What policies to use to regulate positive production externalities

Answer 16

• Gov Provision
• Subsidies

Question 17

What policies to use to regulate positive consumption externalities

Answer 17

• Legislation, Regulation
• Nudges
• Gov Provision
• Subsidies

Question 18

What does the vertical shift represent in positive externalities diagram

Answer 18

The vertical shift represents the value of the external benefits that are ignored as these firms are acting on self-interest in producing from these resources