Answer to Question #215431 in Finance for Precilla

Question

Discuss positive externality in 

consumption. With suitable diagrams,

Answer 1

Solution

Positive externality is when the consumption or production of a good causes a benefit to a third party.

For example:

When one is educated they get a private benefit. But when the rest of society benefits from your education I.e educating others that becomes positive externality consumption.

In positive externality consumption, the benefits to the society are greater than your personal benefits.

Another example is walking to work is more beneficial to the society since it reduces number of cars polluting the environment. In this case the society benefits more than you.

In this case, the social marginal benefit of consumption is greater than the private marginal benefit.

In a free market, consumption will be at Q₁ because demand = supply (private benefit = private cost )

However, this is socially inefficient because at Q₁, social marginal cost is less than social marginal benefit. Therefore there is under-consumption of the positive externality.

Social efficiency would occur at Q₂ where social cost = social benefit