Sunday, September 28, 2014

Market Failure 4 - Positive Production Externality

Positive Production Externality

pajholden - Positive Externalities - Video

Positive Production Externality: The type/name of the externality tells you what you need to do!

Positive = Positive (duh!) (we want more of it)
Production = Production = Costs = Supply (there will be two supply curves, MSC & MPC)
  • Positive = we want more
  • Production = costs = supply
  • Triangle = DWL (dead weight loss) (points to society) & is between the two supply curves
  • SOQ = Socially Optimal Quantity or the quantity desired by society (Pos.= more quantity)
  • Underproduction =  If we want more we must be underproducing the good. (duh!)
  • MSB = MSC, obviously where social benefits and costs equal,  equilibrium quantity- Q*
  • CLG - always a correctly labelled graph
  • Triangle - always points to society - to help you know which supply/cost curve is drawn above or below, know that the triangle always points to (MSC) society for a Positive Production Externality... Your going to say,, but Charles I could draw the curve pointing to the left and still have it between the curves,,, but then the triangles point would be pointing to an equilibrium of less production (we need more).
  • Check your graph and make sure it is showing what you want,,, to get more production prices must go lower. (look above and you will see this is exactly what has happened, prices have increased and quantity produced has fallen.)

An example of a positive production externality would be a case of bee keepers producing honey next to an orchard. Bees help in the pollination of the orchard, causing a benefit (unpaid) to the orchard owner.

Demand in this instance, which always reflects the MPB of buyers of honey, and is identical to the MSB as no external effects of honey consumption are assumed. (D,MSB,MPB)

Supply of honey reflects the MPC of honey producers (costs paid, labour and bees). Since the honey producer's production process entails external benefits to apple growers in the form of pollination, it follows that the social costs of honey production are lower than the private costs that the beekeepers consider. The MSC of honey production are therefore lower than the MPC by the amount of the external benefit created. (Triangle points to Society = MSC)

There is an underproduction of this good, so prices need to be lowered. This is normally done through the use of a subsidy granted to the producer. This decreases the costs of production increasing output levels.

2008 AP Microeconomics Exam
Answer (B) Subsidizing flu shots will lead to the socially efficient level of output. 
                    (socially efficient level = socially optimal quantity)

Reffonomics, excellent website

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