Question

questions for each of the following examples: (i) flu vaccination 1. Answer the following two by individuals; (ii) research and development by a high-tech firm; and (iii) college education by individuals a. Is there an externality? If so, describe it, including references to whether it is positive or negative, and whether it is a consumption or production externality. (20) b. If there is an externality please provide and explain at least one possible public policy option to account for externality for each case based on micro-economic theory(40)

Answer 1

a) The positive externality when the production decision of the firm positively impacts the others and consumption externality is defined as consumption decision of consumer positively impacts the other.

Part i) flu vaccination by an individual is an example of positive consumption externality. This is because the flu is a contagious disease. Thus, vaccination consumption by one individual will reduce the chances of others getting infected by flu, that is, positively impact of consumption flu vaccination by one individual to the rest of the members of the society.

Part ii) The high tech firm will research and produce better technology that will positively impact others as reduce the need for others to research and incur a huge cost. This is an example of the production of externality. As the production decision of the given firm positively impacts the other members of society.

Part iii) The college education by individuals will make informed choice implies that will generate higher value for other society members. This is an example of a positive consumption externality. As consumption decision of individual generates higher value for others, that is, positively impacting the others.

b) The possible solution to positive externality (negative externality) is Subsidy (Pigouvian Tax). Imposing the Subsidy (Pigouvian tax) equal to the marginal external benefit that is a benefit to others (the marginal external cost that is damage to the society). In such a case will internalise the external benefit (the external cost to the society in the case of positive (negative) externality will help in correcting the problem of externality which is explained in the diagram below -

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