Positive Externalities and Market Failure

What is a positive externality?

• A benefit that only the producer receives from a good/service.

• Third-party benefits resulting from consumption/production of good/service. When MSB > MPB due to presence of Marginal External Benefits (MEB). Example: Medical screening benefits both individual and wider community.

• A cost incurred by third parties due to the production of a good/service.

• A situation where the market price is higher than the equilibrium price.

Give 2 examples of subsidies for positive externalities

• Education and healthcare

• Tobacco and alcohol

• Fast food and junk food

• Coal and oil

How do subsidies work to correct positive externalities?

• Government provides per-unit subsidy equal to MEB at socially optimal output, shifting MPC curve downward by the amount of subsidy, increasing production/consumption to socially optimal level.

• Subsidies are given to consumers directly, allowing them to purchase more goods without affecting production levels.

• Subsidies reduce the overall cost of production, leading to a decrease in the quantity supplied in the market.

• Government provides subsidies only to large corporations, which does not affect the overall market equilibrium.

What causes market failure with positive externalities?

• Market produces/consumes at private optimum (where MPB = MPC), leading to over-production/consumption.

• Market produces/consumes at private optimum (where MPB = MPC). But social optimum is at MSB = MSC, resulting in under-production/consumption.

• Market produces/consumes at social optimum (where MSB = MSC), leading to efficient allocation of resources.

• Market produces/consumes at a level where demand exceeds supply, causing market equilibrium.

What are the 3 main policies to address positive externalities?

• Tax incentives, Public awareness campaigns, Direct/Joint provision

• Subsidies, Direct/Joint provision, Legislation/Rules and regulations

• Increased tariffs, Market deregulation, Subsidies

• Legislation/Rules and regulations, Price controls, Public-private partnerships

What factors should government consider when choosing a policy?

• Effectiveness in achieving social optimum

• Public opinion on the policy

• Cost of implementation

• Availability of resources

What is direct/joint provision?

• Government takes over production decisions and can contract actual supply to private firms, such as in the education system in Singapore.

• A method where private firms solely manage production decisions without government intervention.

• A system where consumers directly pay for all services without any government involvement.

• A model where the government only regulates prices but does not influence production decisions.

What is the difference between direct and joint provision?

• Direct provision means the government is the sole provider of services.

• Joint provision means only private sectors provide services.

• Direct provision offers more consumer choice than joint provision.

• Joint provision eliminates competition between service providers.

How do regulations work to address positive externalities?

• Makes consumption/production voluntary without penalties.

• Encourages private sector solutions without government intervention.

• Makes consumption/production mandatory and forces increase to social optimum, e.g., Compulsory Education Act in Singapore.

• Reduces government involvement in education and healthcare.