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What are positive externalities (or external benefits)?
Positive externalities may occur in the production and the consumption of a good or service. An
example of an external benefit in production is the recycling of waste materials such as newspapers,
glasses or tins. It has the benefit of reducing the amount of waste disposal for landfill sites as well as
re-using materials for production.
AN example of an external benefit in consumption is the vaccination of an individual against some
diseases. It reduces the possibility of other people catching the virus who come into contact with the
In a free market, consumers are only concerned with the private benefits or utility from consuming a
good or service. Economists assume this can be measured by the price that consumers are prepared
to pay for a good or service. Private benefits may also refer to the revenue that a firm obtains from
selling a good or service.
By adding private benefits to external benefits we obtain social benefits. This means that external
benefits are the differences between private and social benefits.
MSB=Marginal Social Benefits
MPB=Marginal Private Benefits
MPC=Marginal Private Costs
MSC=Marginal Social Costs
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The difference between MPB and MSB is private benefits.
External Benefits and the triangle of welfare gain
The free market ignores private externalities. However, adding external benefits on to the
consumption of a good or service, such as the consumption of solar energy, causes the demand curve
to shift right and become the marginal social benefit diagram shown below.
When external benefits are ignored there is under-pricing and under-production.…read more
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The government often subsidies goods and services which have significant external benefits, such as
education and healthcare. Subsidies may also be given to alternative forms of economic activity
which create less pollution, such as public transport and renewable energy. The effect of a subsidy is
to reduce the price of renewable energy, leading to an extension in demand. The level of pollution
should fall as consumers switch to renewable energy.…read more