Answer to Question #281111 in Microeconomics for Ali Mammadov

Question

Consider the market for fire extinguishers. a. Why might fire extinguishers exhibit positive externalities? b. Draw a graph of the market for fire extinguishers, labelling the demand curve, the social value curve, 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 €20 per extinguisher, describe a government policy that would result in the efficient outcome. 

Answer 1

a) Fire extinguishers helps in the prevention of fire accidents at the owners' premises and stop the spread of fire. This gives benefit to the purchaser and society showing a positive externality. 

b) Below is a diagram illustrating the positive externality of fire extinguishers. The private value by the individual is given by the demand curve . And the social value curve is above the private value curve. The social cost curve is the same as the supply curve.

c)The market equilibrium level of output is formed at the intersection of demand curve and private cost curve which is denoted by Q_market and the efficient level of output is denoted Q_optimum which is formed at the intersection of the social value curve and supply curve.

The quantities differ because in deciding to buy fire extinguishers, people generally ignore the benefits they provide to other people (positive externality).

d) To internalize the externality a government should provide a subsidy equivalent to the additional benefit or externality gave by the product.

So for the external benefit of $10 received by the society, the government should give a $10 subsidy to the buyers of fire extinguishers. This shifts the demand curve towards its right giving Q_optimum.