Question

Price, Cost 3 P D P4 4 P3 3 C P2 2 B Р. 2 0 21 Q2 Quantity If a positive externality exists then market equilibrium price is P3 P4 OP1 OP2

Answer 1

A positive externality exists if the production or consumption of a good or sevice provides benefits to the other indiviual or trhe society as a whole. For example, if you educate one person in the society, it has benefits for others in the society.

In positive production exernality, social marginal costs (SMC) are less than the private marginal costs (PMC). There is under-production of goods or sevices in this market. In positive consumption externality, social marginal benefits (SMB) are greater than the privatev marginal benefits (PMB). In this situation, there is under-consumption in the market.

The case depicted here is of positive consumption externality where line 1 represents the demand curve i.e. D = PMB, line 2 represents SMB and line 3 represents the supply curve i.e. S = PMC = SMC. In a free market, equilibrium will occure at a point where D = S i.e where PMB = PMC. Thus, the equilibrium price will be P2.

(But this is socially inefficient. The socially efficient price will be where SMB = SMC at P3)

Answer 2

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