Positive externalities are benefits to third parties from certain economic activities. Activities that generate positive externalities include education and training, public broadcasting, healthcare, vaccination programs, and environmental protection. These external benefits are not fully captured by the private market. As a result, the free market underprovides goods and services with positive externalities, leading to a net loss of social welfare. Government intervention, such as subsidies or regulation, may be needed to encourage the optimal level of supply that accounts for positive external spillovers. However, accurately quantifying externalities and avoiding overconsumption can be challenging issues for policymakers.

1. Positive Externalities
AS Microeconomics

2. A quick recap on externalities
 An externality exists when the action of one
agent unavoidably affects the welfare of another
agent.
 The affected agent may be a consumer, giving
rise to a consumption externality, or a producer,
giving rise to a production externality

3. What are positive externalities?
 Positive externalities create benefits to third parties
 Activities said to generate positive externalities
include:
 Social returns from investment in education & training
 Benefits from high quality public service broadcasting
 Positive benefits from health care and medical
research
 Benefits from vaccination and immunization
programmes
 Flood protection systems & fire safety equipment
 Restored historic buildings and monuments
 Social benefits from protecting environmental
resources

4. Social benefits
 Where there are positive externalities the social
benefit of production and/or consumption
exceeds the private benefit

5. Social benefits explained
Private + External benefits = Social
Benefits Benefits
Benefits to Benefits to others of Total benefits to
individual individual society of a
consumers or consumers or firms given economic
firms of their economic activity activity
economic
activity
Benefits to Benefits to third Total benefits
first parties - parties - others to society –
individuals everyone

6. Positive spill-overs
Flood protection schemes,
immunization and galleries and
museums all provide external
benefits
Left to itself, would the free-
market fail to provide sufficient
products that yield positive
externalities?

7. Positive externalities from education
and training
 Improved social skills and awareness of citizenship
 Greater long-term contribution to the economy
 Higher productivity
 Diffusion of knowledge and understanding
 Improved employability / reduced risk of structural
unemployment
 Impact on international competitiveness from an
improvement in human capital
 All of the above should help to contribute to a higher
trend rate of growth
 Higher expected earnings might provide increased
tax revenues for the government

8. Positive externalities and market failure
Costs
and
Benefit
s Marginal
Private Cost =
Marginal
Consumer Social Cost
Surplus
Margin
Produce al
r Surplus
Social
Benefit
Margin
al
Private
Benefit
Equilibriu Q1 Q2 Output
m output

9. Positive externalities and market failure
Costs Gain to
and other
Benefit people
s Marginal
Private Cost =
Marginal
Consumer Social Cost
Surplus
Margin
Produce al
r Surplus
Social
Benefit
Margin
al
Private
Benefit
Equilibriu Q1 Q2 Output
m output

10. Positive externalities and market failure
Costs
and
Benefit
s Marginal
Private Cost =
Marginal
Social Cost
Margin
al
Social
Benefit
Margin
In a free market al
consumption will be at Q1 Private
because Demand = Supply Benefit
(private benefit = private
cost ) Q1 Q2 Output

11. Positive externalities and market failure
Costs
and
Benefit
s Marginal
Private Cost =
Marginal
Social Cost
Margin
al
Social
Benefit
Margin
However this is socially al
inefficient because Social Private
Cost < Social Benefit. Benefit
Therefore there is under
consumption of the Q1 Q2 Output
positive externality

12. Positive externalities and market failure
Costs
and
Benefit
s Marginal
Private Cost =
Marginal
Social Cost
Margin
al
Social
Benefit
Margin
Social Efficiency would al
occur at Q2 where Social Private
Marginal Cost = Social Benefit
Marginal Benefit
Q1 Q2 Output

13. Positive externalities and market failure
Costs Welfare loss from
and the good being
Benefit under-consumed
s Marginal
Private Cost =
Marginal
Social Cost
Margin
al
Social
Benefit
Margin
Under-consumption of al
products with positive Private
externalities leads to a net Benefit
loss of social welfare –
shown in the diagram above Q1 Q2 Output

14. Encouraging supply to reap social returns

15. Government intervention options
 Government subsidy either to producer or consumer
 Reduce private cost of consumption or reduce cost of supply
 Lower costs should cause an expansion of demand
 E.g. Student grants and low-cost loans?
 Subsidies to fund free entrance to museums and heritage
sites
 Providing free vaccines at the point of use
 Command and Control techniques
 Minimum school leaving age
 Compulsory health immunisation programmes
 Improved information flows to potential consumers
 Health awareness programmes
 Goods with positive externalities are often public goods –
e.g. Investment in reduction programmes for communicable
diseases

16. A subsidy to the producer
Costs Welfare loss from
and the good being
Benefit under-consumed
s
MPC=MSC
MPC with
subsidy
MSB
A producer subsidy would MPB
cut the marginal cost of
supplying to the consumer –
a lower price would bring
about an expansion of Q1 Q2 Output
demand towards the socially
optimal level

17. Evaluation points
 Often difficult to identify the positive externalities
and then put a market value on them
 People/organisations may have an incentive to
over-estimate the spill-over benefits when
lobbying for financial assistance
 Providing services ‘free at the point’ of need may
cause over-consumption
 Subsidies always carry an opportunity cost
 Regulation consumption involves a cost too

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