Question

If positive externalities do arise, then what is a possible government policy that could

correct the market failure?

Answer 1

Positive externalities occur when benefits of an economic transaction spills over. To correct the market failure caused by the positive externality, government can provide subsidies for goods and services that create positive externalities. A subsidy is the payment that effectively lowers the cost of producing a good or service. This will create incentive for firms to produce more of the goods that provide positive externalities. A subsidy equal to the marginal private benefit will cause the private market equilibrium quantity to move towards the socially efficient quantity and thus externality will be internalized.