Question

#3. 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 cruve, the social-value curve, the supply curve, and the social cost curve.
c. indicate the market equilibrium level of the output. give and ointuitive explanation for why these quantities differ.
d. if the external benefit is $10 per extinguisher, describe a govt. policy that would yield the efficient outcome.

Answer 1

Because fire extinguishers exhibit a positive externality, the demand curve does not reflect the value to society of the good. Therefore, the social-

value curve lies above the demand curve, and the social-cost curve is equal to the supply curve. 

The market equilibrium level of output occurs where quantity demanded equals quantity supplied, or where the demand and supply curves intersect. However, the efficient level of output occurs where the social-value curve and the social-cost curve (which is supply in this case) intersect. Therefore, the socially optimal quantity is greater than the quantity that the private market would naturally reach on its own. 

Suppose the external benefit is $10 per extinguisher.

True or False: Subsidizing people $10 for every fire extinguisher they buy would yield the efficient outcome.

True

The government can correct the market failure by inducing market participants to internalize the externality. The appropriate response in the case of positive externalities is to subsidize consumers in order to encourage them to purchase more of the good. In this case, a subsidy of $10 per fire extinguisher would yield the efficient outcome given the external benefit of $10 per fire extinguisher.