Question

Explain in words what we mean by a positive externality, and use a graph to illustrate its effect on a market, being sure to label all curves.  Indicate on your graph the socially optimal output level (Q*), the output level of a private market (Q_P), and any deadweight loss.

Answer 1

A positive externality occurs when a production or consumption activity gives benefits to a third party, such as a garden gives beautiful scenes to others, public libaries gives everyone acces to knowledge, vaccines gives immunization to those who took it , deforestation helps to reduce global warming. When there is a positive externality the free market equilibrium is much less than the private market equilibrium output, this is because the private market outcome ignores the positive externalities.

The above given graph shows the positive externality in the production, the socially optimal level of output is Q* and the price is P*. The private market output is QP and the dead weight loss is shown by the red shaded triangle area.