How does government correct for positive externalities? Does government do it by: taxing consumers? taxing producers? subsidizing producers? separating ownership from control?    



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pohnpei397's profile pic

Posted on (Answer #1)

First of all, we should note that government is not really trying to “correct for” positive externalities.  These are good things, so what government is really trying to do is to encourage positive externalities.  Of the choices that you have given, it does this by subsidizing producers.

For example, education brings with it positive externalities.  The government promotes this in part simply by providing free public education at the primary and secondary levels.  But it also subsidizes providers of things like higher education as it gives large amounts of aid to universities both public and private. 

kplhardison's profile pic

Posted on (Answer #2)

With positive externalities, less is produced and consumed than the socially optimal level. (B. Taylor, "Positive Externalities")

Positive Externalities

The reason it may be said that government "corrects" for positive externalities is that, in the case of positive externalities, the "benefit to the individual or firm is less than the benefit to society" (Taylor). This is because private marginal cost and private marginal benefit are less than social marginal cost and social marginal benefit. That is to say that if the full benefit of positive externalities were to be realized for all of society, the cost of the commodity or service would be far higher for all individuals than they would be willing to pay. High social marginal cost is the reason unacquired positive externalities are corrected for by government.

Some examples of positive externalities that government may choose to correct for are disease vaccinations (currently very controversial) to keep all of society free of serious and disabling disease, like polio and small pox; educational opportunities at all levels expressed as free public education at lower levels and funded education at higher levels; health care availability to promote a healthy and able work force and general population; and waste management to prevent public filth and disorder.  

As explained by Tejvan R. Pettinger, government correction aims to correct, or close, the gap between the private marginal benefit and the social marginal benefit by increasing the Quantity from Q1 with a shift to the right to Q2 and by reducing the Price from P1 downward to P2. This shifts the whole curve to the right from S1 to S2 where Supply equals Private Marginal Cost and Social Marginal Cost (S = PMC = SMC), where S1 results in positive externalities and S2 (the rightward S2 shift) results in correction of positive externalities so that more people consume more and social efficiency is reached. Under government correction of positive externalities:

  • The supply curve shifts to S2 and price falls from P1 to P2
  • People will now consume more, the quantity increases from Q1 to Q2.
  • Q2 = Social Efficiency: because SMC = SMB (Tejvan R. Pettinger, "Subsidies for Postive Externalities")

Government Subsidies of Producers

The means by which government instigates a rightward shift in the graph showing positive externalities is to provide subsidies for the population for whom unacquireable positive externalities exist. In other words, in society beneficial goods, like education, which have positive externalites in the form of widespread benefits, cannot be consumed at optimal social levels because their cost are too high. Government optimizes consumption by subsidizing producers so as to effectively reduce cost for individual consumers. The most familiar example of the government subsidizing producers is the subsidies for education through which government pays part of the cost of education through subsidized grants and through subsidized low-interest loans. Some countries have government subsidized health care to the extent that equal-standard health care is free and available to all.

In order to get consumers to consume more of a good that has a positive externality, a subsidy can be given to them. The subsidy will increase the marginal benefit they receive when they consume the good. (B. Taylor, "Positive Externalities")


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