Explain how positive externalities cause a wedge between private marginal costs and social marginal costs. Give an example of a positive externality and explain why it is, in fact, a positive externality. Draw a supply/demand diagram and add a social marginal cost curve that represents the presence of the positive externality. Explain the relationship between the equilibrium quantity and that which is socially efficient.

Question

What will be an ideal response?

Answer 1

Positive externalities indicate that there is some benefit to the productive process that the firm engaging in production does not receive. That is, the fact that the firm is producing the good gives a benefit to another party despite the fact that the other party incurs no production costs. An example of a positive externality is when stores in shopping malls advertise. This is a positive externality because not only does the advertisement attract customers to the store that places the ad, but it also increases foot traffic for nearby stores. The social marginal cost curve would lie down and to the right of the industry supply curve. Hence, the quantity produced in the industry would be less than the socially efficient amount.