Positive Externalities of Production
- Positive externalities of production are often created during the production of a good/service
- The externalities are caused by producer supply and result in a positive external impact on a third-party
- The externalities are caused by producer supply and result in a positive external impact on a third-party
- The market is failing due to under-provision of these goods and services, as only the private benefits are considered by the producers and not the external benefits, causing market failure
- If the external benefits were considered, the quantity of goods and services produced would increase, and they would be sold at a lower price
- E.g. The production of honey increases the number of bees in an area, which increases pollination potentially helping other food producers in the area
Diagram: Positive Externality of Production
External benefits of production (positive externality) resulting in an under-production equal to Qopt - Qe
Diagram analysis
- The marginal social benefit (MSB) is assumed to equal the marginal private benefit (MPB) as the focus is on the producer (supply) side of the market
- The free-market equilibrium can be seen at PeQe. This is where the MPC = MSB
- The larger the external benefits in production, the larger the gap between the marginal social cost (MSC) and the marginal private cost (MPC)
- The optimum allocation of resources from society’s point of view would generate an equilibrium where MSB = MSC. This can be found at PoptQopt. There is no market failure at this equilibrium
- The free market is failing due to under-provision of this good/service equal to Qopt - Qe
- At any quantity produced below Qopt, the MSB is greater than the MSC, resulting in lost benefits and a deadweight loss to society (pink triangle)
- To be socially efficient, more factors of production should be allocated to producing this good/service
- There is an opportunity for government intervention (indirect taxes, legislation, regulation, etc.), to force this market to be more socially efficient
- Any intervention that reduces the welfare loss will be beneficial