2. Consider the market for fire extinguishers. a. Why might fire extinguishers exhibit positive externalities? b....

2. Consider the market for fire extinguishers.

a. Why might fire extinguishers exhibit positive externalities?

b. Draw a graph of the market for fire extinguishers, labeling the demand curve, the social-value curve, the supply curve, and the social-cost curve.

c. Indicate the market equilibrium level of output and the efficient level of output. Give an intuitive explanation for why these quantities differ.

d. If the external benefit is $10 per extinguisher, describe a government policy that would yield the efficient outcome.

Expert Solution

a) There is a positive externality associated with an activity when the benefits extend to non market participants. In case of fire extinguishers, prevention of one house from fire helps in immunizing nearby houses. Hence other non-market participants are also benefitted when fire extinguishers are used so there is a positive externality

b) Graph is shown below. Supply curve and social value curve is same MSC. Demand curve is MPB and social value curve for buyers is MSB which includes an external benefit

c) Market outcome is e where price is P1 and quantity is Q1. Efficient outcome is f where price is P2 and quantity is Q2. Quantities differ because private equilibrium is unable to capture the extended external benefits which are visible only when the externality is internalized.

d) Government can provide a subsidy of $10 to each fire extinguisher. This will shift the MPB up by $10 to reach MSB and this causes the market to have a social outcome at f

Rahul Sunny answered 2 years ago

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