Question

a)Explain why the intersection of the market demand curve and market supply curve yields an inefficient amount of output produced and consumed when a positive demand side externality exists.

b) use a graph to show the deadweight loss that would occur in a) in the absence of government intervention.

c) describe a government intervention that would generate an efficient amount of output produce and consumed from societies perspective. Use a graph to show the effect of the government intervention.

Answer 1

Ans) Positive externality is when the bystander bears the benefit of any activity. Here social benefit is more than the private benefit. When the consumer does not take into account the external benefit, goods are underconsumed and underproduced. For eg- when a person takes vaccine, alongwith that person, the society is also benefitted because by taking the vaccine, that person has prevented the spread of harmful viruses.

To internalise this externality, government gives subsidy equal to external benefit. Subsidy decreases the price and brings the market quantity equal to socially optimal quantity.

Key points÷

• Goods are underconsumed as private benefit is less than the social benefit.
• Without government intervention, goods will be under consumed.
• Government gives subsidy to internalise this externality.

Above graph depicts market with positive externality and without government intervention. Qs is socially optimal quantity and Qm is market quantity. Qm is less than Qs as external benefit us not taken into account.

Above graph shows that government provides subsidy equal to external benefit and now the quantity becomes equal to socially optimal quantity.