Question

Suppose that the market for flu shots has downward sloping demand and upward sloping supply and that flu shots yield a positive consumption externality of $5 per shot. Show graphically how the private optimum may differ from the social optimum and indicate the deadweight loss. Additionally, show graphically how a subsidy for flu shots can achieve the social optimum.

Answer 1

Private optimal equilibirium point is at E1 wher marginal private cost equals marginal private benefit.

Positive externality leads to margianl social beneift more than margianl private benefit. Social optimal equilibirium point is at E2 wher marginal social benefit equals marginal private cost.

This increases price and quantity to P2 and Q2 respectively.

The government should provide a subsidy to producer = P1- P3 in order to increase supply and reach E3 where at same price more output is produced.