Overview
This lecture introduces positive externalities and public goods, focusing on how the free market can underprovide beneficial goods due to external benefits not being considered by private decision-makers.
Positive Externalities in Supply and Demand
- Positive externalities are spillover benefits to society from individual market transactions.
- Examples include innovation and education, where private actions benefit both individuals and the broader community.
- The private benefit is the value received by the individual, while the social benefit includes both private and external (societal) benefits.
- The demand curve can represent marginal private benefit, but marginal social benefit is higher when external benefits exist.
- In a supply and demand graph, the market outcome considers only private benefits, resulting in underproduction compared to the efficient outcome.
- The efficient outcome is where marginal social benefit equals marginal private cost (supply curve).
- Markets with positive externalities tend to produce less than the socially optimal quantity of goods.
- Examples include vaccines, education, and planting flowers, all of which have benefits beyond the individual consumer.
Market Solutions to Positive Externalities
- Subsidies can correct underprovision by lowering costs or providing financial incentives to align private benefit with social benefit.
- The optimal subsidy equals the difference between the marginal social benefit and the marginal private benefit.
- Real-world examples: Subsidies for flu shots and education increase consumption to efficient levels.
Key Terms & Definitions
- Positive Externality — A benefit from a transaction that impacts others beyond those directly involved.
- Marginal Private Benefit (MPB) — The benefit received by an individual consumer from consuming an additional unit of a good.
- Marginal Social Benefit (MSB) — The total benefit to society from consuming an additional unit, including external benefits.
- Subsidy — A government payment or incentive to encourage consumption or production of a particular good.
Action Items / Next Steps
- Review supply and demand diagrams illustrating marginal private and social benefits.
- Prepare for Part 2: The four types of goods and further discussion on public goods.