• The supply curve can be called the Marginal Social Cost

• The demand curve can be called the Marginal Social Benefit

• Externality is the third part effect due to a production or a consumption of a commodity. If the effect is harmful, the externality is negative . If the effect is beneficial, the externality is positive. If no externalities exist, socially efficient allocation of resources, maximum community surplus, no market failure. Vice versa

• 4 types of externalities:

  • Positive and negative externality of production
  • Positive and negative externality of consumption

• Marginal Social Benefit = Marginal Private Benefit + Marginal External Benefit (positive or negative)

• Marginal Social cost = Marginal Private cost + Marginal External cost (positive or negative)

Positive externality of consumption

• Merit goods are goods which have a positive externality and these are usually under produced and under consumed. They are beneficial to those who consume them and also provide external benefits to third parties.

• Marginal Social cost > Marginal Private cost

  

Fig 2

• In a free market people will consume where the MSC meets MPB at Q1 but socially efficient level of consumption will be at Q where MSC = MSB. Under-allocation of resources to this market.(welfare loss). If quantity is increased welfare to the society will increase.

• Link to the PPC curve

• Higher consumption of them will lead to socially desirable conditions

• Examples of merit goods are education and healthcare (vaccines)(covid 19)

• Merit goods tend to shift the PPC outwards

• Government aims to increase the demand of merit goods (consumption) by :

  • Legislation: Passing laws. PROBLEMS : people resent laws, needs to be provided free of charge
  • positive advertising : Increased awareness, causes MPB to shift to the right towards MSB, increasing welfare. PROBLEMS: high cost, long time to take effect
  • subsidising : Shifts MPC downwards, lowers price, causing extension in demand so that socially efficient level of consumption is reached. PROBLEMS : Limited budged, opportunity cost, reallocation of budget. (fig 2)

  Positive externalities of Production

• Production of a good or service creates external benefits that are favourable for third parties. Society gains whereas the firm does not. Therefore MSC < MPC which is socially undesirable.

• Positive externality of production increases the supply curve and shifts it downwards

• Firm would produce at Q1 where MPC meets MSB but it's below the socially optimum output Q where MSB meets MSC. There is a welfare loss. Under-allocation of resources as firm would not want to incur higher costs for society's gain.