Definition of Positive Externality: This occurs when the consumption or production of a good causes a benefit to a third party. For example:
- When you consume education you get a private benefit. But there are also benefits to the rest of society. E.g you are able to educate other people and therefore they benefit as a result of your education.
- A farmer who grows apple trees provides a benefit to a beekeeper. The beekeeper gets a good source of nectar to help make more honey.
- If you walk to work, it will reduce congestion and pollution, benefiting everyone else in the city.
With positive externalities the benefit to society is greater than your personal benefit.
Therefore with a positive externality the Social Benefit > Private Benefit
- Remember Social Benefit = private benefit + external benefit.
Diagram of Positive Externality
- In a free market consumption will be at Q1 because Demand = Supply (private benefit = private cost )
- However this is socially inefficient because Social Cost < Social Benefit. Therefore there is under consumption of the positive externality.
- Social Efficiency would occur at Q2 where Social Cost = Social Benefit
For example, in a free market without government intervention, there would be under-consumption of education and public transport.