what are positive externalities?
Positive externalities exist when the marginal social benefit of production and or consumption exceeds the marginal private benefit i.e. production and/or consumption generate external benefits that may go under-valued by the market
There are plenty of examples of economic activities that can generate positive externalities:
Industrial training by firms: This can reduce the costs faced by other firms and has important effects on labour productivity. A faster growth of productivity allows more output to be produced from a given amount of resources and helps improve living standards throughout the economy. See the revision notes on the production possibility frontier
Research into new technologies which can then be disseminated for use by other producers. These technology spill-over effects help to reduce the costs of other producers and cost savings might be passed onto consumers through lower prices
Education: A well educated labour force can increase efficiency and produce other important social benefits. Increasingly policy-makers are coming to realise the increased returns that might be exploited from investment in human capital at all ages.
Health provision: Improved health provision and health care reduces absenteeism and creates a better quality of life and higher living standards.
Employment creation by new small firms
Flood protection system and spending on improved fire protection in schools and public arenas
Arts
and sporting participation
POSITIVE EXTERNALITIES AND MARKET FAILURE
Why do positive externalities lead to a failure of the normal free-market mechanism?
Where substantial positive externalities exist, the good or service may be under consumed or under provided since the free market may fail to take into account their effects. This is because the marginal social benefits of consuming the good > private marginal benefits. In the case of external benefits from production, the marginal social cost would be < private marginal costs.
Consider the example of health care. Good quality health care brings positive spillover effects both for the recipient of the care but also their families and associates. A well functioning health care system also reduces the scale of absenteeism from work due to sickness and illness.
We see in the diagram above how the provision and consumption of health care services leads to an increase in social benefits and a reduction in social costs. As a society we should be encouraging people to increase their consumption of health care services.
Positive externalities from technological spillovers
In the diagram below we assume there has been a positive externality in production in the form of a technology spillover. The use of new technology has brought down costs to other producers - social cost lies below private cost and output of the product (i.e. a new robot or piece of software) should be encouraged towards output Qb rather than the private optimum Qa. This might be achieved through the use of a producer subsidy that reduces the cost of production / consumption and encourages an expansion of supply in the market
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