Positive Impacts Of Externality: The Anatomy Of Market Failure

An externality is a cost or benefit that is imposed on someone by the actions taken by others. Externalities can arise from consumption or production and can be positive or negative.

Positive externalities impose benefits on the third party involved in an economic transaction. Positive consumption externalities occur when the consumption of one individuals good has a positive effect on another but the individual is not compensated by the other person, for example, getting vaccinations so many people do not get sick or a neighbours well kept property increasing the market value of your property. Positive production externalities develop when a firms production benefits another individual without the firm being compensated for this benefit,

(1958) states that market failure is the ''...failure of a more or less idealized system of price-market institutions to sustain ''desirable'' activities or to estop ''undesirable'' activities.'' The Anatomy of Market Failure 72,(3),351-379. Externalities lead to market failure because they cause Pareto inefficiency. This is because either too much of a scarce resource is designated to an activity which in turn leads to a negative externality or else too little of a resource is designated to an activity which leads to a positive externality. Equilibrium is assumed to result in the optimal level of output and price for a good. However when externalities are present it is said that there is market failure because the equilibrium does not exactly reflect the true costs or benefits that are associated with the

Marginal Private Benefit (MPB) is the net private value of the product to the consumer for every additional unit consumed. Marginal Private Cost (MPC) is the net private cost of the product for every additional unit produced. The above diagram shows what happens when the positive externality of vaccinations is introduced. Marginal Social Benefit (MSB) is the net social value of a product to society for every additional unit consumed. The MSB line lies above the MPB line, when MSB does not equal MPB the outcome if inefficient. We can see that a dead weight loss is present (triangle in middle of diagram). In this case the social quantity demanded is greater than the private quantity demanded. That is, there is too little consumption of vaccinations which leads to inefficiency and market failure.

It is in the governments best interest to increase the consumption of vaccinations as it leads to a higher standard of living. Therefore in this case the government might introduce a subsidy to decrease price and help stimulate consumption. Subsidies for a good will encourage firms to produce products with positive externalities and can change preferences in the long