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Question from Past Microeconomics Qualifying ExamEdit

Spring 2005 - Section II, Question four, George Mason University

Diagram a situation where there are large positive externalities but laissez-faire still yields a perfectly efficient result. Suggest a real-world example.

AnswerEdit

The graph below shows the effects of a positive or beneficial externality. For example, the industry supplying smallpox vaccinations is assumed to be selling in a competitive market. The marginal private benefit of getting the vaccination is less than the marginal social or public benefit by the amount of the external benefit, i.e., the fact that if one person gets the vaccination, others are less likely to get the smallpox even if they themselves are not vaccinated. This marginal external benefit of getting a smallpox shot is represented by the vertical distance between the two demand curves. Assume that there are no external costs, so that social cost equals individual cost.

If consumers only take into account their own private benefits from getting vaccinations, the market will end up at price Pp and quantity Qp as before, instead of the more efficient price Ps and quantity Qs. These latter again reflect the idea that the marginal social benefit should equal the marginal social cost, i.e., that production should be increased as long as the marginal social benefit exceeds the marginal social cost. The result in an unfettered market is inefficient since at the quantity Qp, the social benefit is greater than the societal cost, so society as a whole would be better off if more goods had been produced. The problem is that people are buying too few vaccinations.

The issue of external benefits is related to that of public goods, which are goods where it is difficult if not impossible to exclude people from benefits. The production of a public good has beneficial externalities for all, or almost all, of the public. As with external costs, there is a problem here of societal communication and coordination to balance benefits and costs. This also implies that pollution is not something solved by competitive markets. The government may have to step in with a collective solution, such as subsidizing or legally requiring vaccine use. If the government does this, the good is called a merit good.

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How is the result described, or the graph, an efficient result? Everything here appears to illustrate an inefficient result.

I tried this one: There is a societal benefit from the collective political pressure exerted by bloggers, but the private willingness to pay to read blogs is zero beyond a certain low number of blogs, while many blogs are supplied at P=0.

Efficient positive externality

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