Elearneconomics – Positive externalities of consumption

The free market equilibrium considers only the costs and benefits to private producers and consumers. In a free market goods and services are produced where demand = supply (marginal benefit = marginal cost, MB=MC).

The social market equilibrium includes spillover costs and benefits to society as a whole. When externalities are considered the social equilibrium is where marginal social cost = marginal social benefit (MSC=MSB). This requires that any spillover benefits or costs are added to the private benefits and cost at each level of production or consumption. MSC=MSB is a more desirable output than where MC=MB because it reflects social preferences, achieves allocative efficiency and there is no deadweight loss.

Positive externalities of consumption

There are positive benefits to society from the consumption of certain products such as getting an education, wearing seat belts, going to the gym, learning to swim and getting immunised. Individuals who decide to make use of public transport (buses, trains and ferries) rather than driving to work create benefits to other people. As more consumers catch a bus to work it results in less traffic and congestion on roading networks and reduces travel time for other commuter as well as causing less pollution.

Without considering the spillover effect on society of public transport, consumption is where MB = MC, at Qm and Pm. Public transport represents market failure because it is overpriced and under consumed.

The private marginal benefit curve (MB) is below the social marginal benefit curve (MSB) because the private benefit curve reflects that society does not consider the spillover benefits to society from individuals who use public transport. There is a misallocation of resources (deadweight loss) at the private equilibrium shown by the shaded are DCA

From society’s point of view, consumption should be at a lower price and greater quantity. The marginal spillover benefit added to the private benefit gives the marginal social benefit curve shown on the diagram. The best outcome is at Ps for a weekly ticket and Qs trips made, which would require a subsidy per unit shown as the gap between the MB and MSB curve. The total cost of the subsidy is represented by the are JABK. A subsidy on public transport would be deemed fair (equitable) because those who are causing the positive spillover benefit pay less and are rewarded because they are assisting society to get what it desires.

For more on externalities of consumption and production view the key notes (accompanied by fully coloured diagrams/models) on elearneconomics that will assist students to understand concepts and terms for external examinations, assignments or topic tests.