Question

Suppose that scientists have discovered that the production of honey has a very significant positive externality. The main input into honey production, honey bees, are most effective when there are orchards nearby. The bees gather nectar from the orchards and simultaneously pollinate the orchard. This pollination is very valuable to the orchard. However, honey firms (beekeepers) are not compensated for this positive impact on orchards. This positive externality means that the true marginal social value of producing honey is different than the marginal private value of the consumption of honey. Indeed, the Marginal Social Value for the industry would be the sum of the marginal private value (the demand curve) plus the positive impact each unit of honey production has on orchards. That is, in the eyes of the benevolent dictator, the production of honey has Marginal Social Value per unit higher than the marginal private value (the demand curve). Construct another graph. Show the original demand and supply (labeled correctly as D0 and S0) and equilibrium price (P0) and quantity (Q0). Now add another curve that reflects the Marginal Social Value given the existence of the positive externality, and label it appropriately. What, if anything, happens to price and quantity of honey established in the marketplace, given the presence of this positive externality? What is the output QSO6 the Benevolent Dictator would choose (where SO6 stands for Socially Optimal output here in question 6, which may or may not be different than the socially optimal output you found in question 5)? Indicate graphically and explain in a narrative the area of deadweight loss (DWL), if any, given the existence of this positive externality. What does deadweight loss mean in this context?

Answer 1

The graphh indicating S0, D0, Q0 and P0:

When honey bees give out positive externalities, MSB (marginal social benefit) is the new curve. Now the desired output is Q1 which is greater than Q0. P1 greater than P0 is the new price.

The orange triangle at the center, between Q0 and Q1 above P0 is the deadweight loss.

DWL indicates the opportunity cost to the society. It is the difference between what is produced and what should have been produced.This is because, at Q0, marginal social benefit is greater than individual private cost (the demand curve of the individual making the decision). So less is produced than socially optimum. Consumers pay P0 and consume Q0. As seen in the graph, this is below the socially optimum quantity of Q1 at price P1. That is why the situation results in dedweight loss.