Question

In the lecture videos, we discovered that when an activity also produces a positive externality, the marginal social benefit (MSB) from that activity was different than the marginal private benefit (MPB) curve (the MPB is also known as our demand curve). State what this difference is and explain the reason for that difference.

We also discovered that the socially optimal level of this activity would be systematically different than what the market would produce. Explain that difference.

Answer 1

                        A positive externality is said to exist if the production and consumption of a good or service would bring in benefit to a third party in the process just like how education would bring in benefit to the society also along with the benefit to the individual. The Marginal Social Benefit [MSB] is the change in benefit associated with the consumption of and additional unit of good or service in the market. The measurement is given by the amount that the people are giving to pay for an additional unit of the commodity. The Marginal Private Benefit [MPB] is the benefit enjoyed by the individual consumers which doesn’t take in to consideration the external benefit or the cost arising from consumption of goods. When there is a positive externality, it would mean that the social benefit arising out of the same would be more than the private benefit since the third party would be having a benefit other than the individual under consideration. Thus, when the demand curve is drawn, we can see that the two benefit structures would be different which would mean that there would be a difference in the curve between MSB and MPB.

                        The socially optimal level of an economic activity gives the optimal level that the activity would induce in the society as a result of the economic interaction of the activity with the society. The socially optimal level of such an activity that has a positive externality would be such that whatever the market would produce would be different from the same. The effect of a positive externality would be that the production made by the market would have an effect that makes sure that the optimal level of the society would be higher than the market production and hence the difference would be seen.