Positive Externality
What is Positive Externality?
A positive externality is a benefit enjoyed by a third party not involved in a transaction, such as vaccination or education.
Because buyers ignore these external benefits, the market underproduces relative to the socially optimal quantity. The marginal social benefit exceeds the marginal private benefit. Governments correct it with subsidies or public provision.
Positive Externality: a worked example
A clinic's flu shot market has marginal private benefit MPB = 40 - Q and marginal cost MC = 10 + 2Q, and every shot spares bystanders infection worth $9. Buyers weigh only their own benefit: 40 - Q = 10 + 2Q gives Q = 10 shots at a price of $30. Marginal social benefit is MSB = 49 - Q, so efficiency needs 49 - Q = 10 + 2Q, giving Q = 13 shots where marginal social benefit and marginal cost both equal $36. Three shots society values above their cost never get bought, and the deadweight loss is 0.5 x 3 x 9 = $13.50. A $9 per shot subsidy closes the gap: buyers pay 40 - 13 = $27, providers receive $36, and the program costs 9 x 13 = $117.
The mistake students make with positive externality
The price buyers pay gets read off the wrong curve. Having found the efficient quantity of 13 shots where marginal social benefit meets marginal cost, students report that buyers now hand over the $36 sitting on the marginal social benefit curve at that quantity. More output feels like it should require a higher price, which is what sells the error. Buyers slide down their own demand curve to $27, below the original $30, and the $9 subsidy supplies the rest so providers still collect $36. A subsidy is precisely what pries the two prices apart.
Positive Externality questions
Why does a positive externality cause underproduction?
Buyers pay for a good based on the benefit they personally receive, and spillover benefits reaching other people never enter that calculation. Demand therefore sits below marginal social benefit, and the market stops at a quantity where society still values another unit more than it costs to produce. Those missing units are the deadweight loss, which is why the recommended policy expands output rather than shrinking it.
How does a subsidy fix a positive externality?
A per unit subsidy equal to the marginal external benefit closes the gap between what buyers will pay and what society gains. Sellers collect the buyer price plus the subsidy, so supply effectively shifts down until the new equilibrium quantity matches the point where marginal social benefit equals marginal cost. Buyers pay less, output rises to the efficient level, and the deadweight loss triangle disappears.
What are examples of positive externalities?
Vaccination, education, home restoration, and basic research all generate benefits for people who never paid. A vaccinated neighbor lowers your own chance of infection, a well kept house raises the value of the ones beside it, and published research lets other firms build on results they did not fund. On an exam, name the third party and the benefit reaching them, since that pairing is what earns credit.
Formula / Example
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