Question

Consider the market for fire extinguishers

A)Why might fire extinguishers exhibit positive externalities?
B) Draw a graph of the market for fire extinguishers, labeling the demand curve, the social-curve, the supply curve, and the social-cost curve
C) Indicate the market equilibrium level of output and the efficient level of output. Give an intuitive explanation for why these quantities differ
D) If the external benefits is $10 per extinguisher, describe a government policy that would yield the efficient outcome

Answer 1

a) Fire extinguishers not only prevents fire accidents at the owners premises but also helps in stopping the spread of fire and smoke to the neighborhood, thus exhibiting benefit not only to the purchaser but also to the society showing appositive externality.

b)

The figure illustrates the positive externality of fire extinguishers. Here the private value or the price paid by the individual is given by the demand curve or private value curve. And the social value curve is above the private value curve. The social cost curve is the same as the supply curve.

c)
The market equilibrium level of output is formed at the intersection of demand curve and private cost curve which is denoted by Q_market and the efficient level of output is denoted Q_optimum which is formed at the intersection of social value curve and supply curve .
The quantities differ because in deciding to buy fire extinguishers, people generally ignore the benefits they provide to other people (positive externality).

d) To internalize the externality a government should provide a subsidy equivalent to the additional benefit or externality given by the product.
So for the external benefit of $10 received by the society, government should give a $10 subsidy to the buyers of fire extinguishers. This shifts the demand curve towards its right giving Q_optimum.