Download Positive Externalities of Production

Positive
Externalities of
Production
Where the production of
goods has spill over
benefits, the producers MC
curve does not fully take
account of the cost
savings to the other
producers advantaged.
ECO 13/4/3
Positive Externalities of Production

An example could be the planting of
forests in an arid area helps to create a
micro climate more suitable for other
farming operations. The improved climate
cuts down the need for extra irrigation
lowering their costs.
Positive Externalities of Production
This causes a loss of efficiency as the
private equilibrium results in underproduction
 Under production results in output being
produced where the social costs are lower
than the social benefits, so some welfare
gain is being forgone, causing dead weight
loss .

Positive Externalities of Production
The forestry producer
considers their private cost
and benefit and will produce
Qm where MC=MB at a
price of Pm.
The spill over benefits
result in a lower social
cost to producers giving
us the Marginal Social
Pm
Cost curve MSC.
When all the benefits are Ps
taken in to account the
Socially Desirable outcome
would be more production at
Qs and a lower price to reflect
the true costs Ps
MC
MSC
Spill over
benefits
MB
Qm Qs
Positive Externalities of Production
At Qm the MSC<MB which
means benefits exceed the
costs of production.
MC
MSC
The effieicency gain not
utilised results in a Dead Pm
Weight Loss for the
Ps
economy.
This is shown as the area
of benefit exceeding cost,
representing welfare
forgone
MSC < MB
DWL
MB
Qm Qs
Positive Externalities of Production
If we were to produce at Qs
rather than Qm, there would
be a gain in spill-over
benefits
The move to this level of
quantity involves private
marginal costs exceeding
private marginal benefit
Overall, the increased
gain in spill-over benefits
is greater than the
marginal loss, so is a
potential efficiency gain
not utilised, a Dead
Weight Loss
MC
MSC
Pm
Ps
DWL
MB
Qm Qs
Positive Externalities of Production
In order to achieve the socially
desirable output and price. The
government could subsidise
(=spillover benefit at Qs) the
production creating the
spillover benefits.
This will result in a dual price
supply shown with the curve
MC’
MC
MSC =MC’
Pm
Required
subsidy
Ps
MB
Qm Qs
Positive Externalities of Production
The subsidy results in an
increase in spill-over
benefits
MC
The move to this level of
quantity involves private
marginal costs exceeding
private marginal benefit
MSC
Pm
Overall, the increased
Ps
gain in spill-over benefits
is greater than the
marginal loss, giving an
efficiency gain, eliminating
the Dead Weight Loss
Efficiency gain
MB
Qm Qs
Positive Externalities of Production
Internalising the Externality
By subsidising the costs of the firm increase to
reflect the external benefits, these spill over
benefits have reduced internal costs.
External
Benefit
Internal:
Firms Private Costs
Positive Externalities of Production

To be totally effective, the cost of the
subsidy should be paid for by the
producers benefiting from the spill over
benefits rather than from general taxation.
The government could tax these
producers to pay for the subsidy.