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Course: AP®︎/College Microeconomics > Unit 6
Lesson 2: ExternalitiesPositive externalities
Explore the concept of positive externalities through a hypothetical market for a certain type of tree. You'll see how the increasing the quantity of trees impacts marginal cost curve for supply, as the price increases with each additional tree. You'll also see how positive externalities can capture benefits of consumption that are not present in a demand curve. Created by Sal Khan.
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Do not all economic transactions or activities have both positive and negative externalities associated with them? If I buy deodorant, I create the positive externality of smelling good to those around me. Should I get a tax credit or government subsidy for my purchase. On the other hand, while driving to the store to make my purchase I create pollution and crowd the roads. Should I be taxed for that?(22 votes)
In a sense, there are "externalities" associated with all economic activities; but by no means in equal proportions as between negative and positive externalities. Beware of false equivalencies. In your example, the "benefit" of smelling good is imperceptible to almost everyone, and certainly not deserving of a public subsidy. But if you drove on a public street to get to the store, then of course you should be taxed to pay for the road; and to the extent that you created some air pollution by driving (versus walking, biking, etc..), how would you propose that you should pay for that pollution, other than by some kind of tax?(44 votes)
This might be a stupid question, but as no questions are really stupid I'm still going to ask it:
I understand that the supply curve in this example is upwards-sloping - the higher the price for a nice tree, the more suppliers are willing to plant them. But why would the Marginal Cost curve be the same - why would the MC be upwards-sloping? As I understand it, it takes some initial capital sum to open a plant nursery, so the Marginal Cost for the first trees might be quite high. But then, should it not get cheaper and cheaper for each additional tree to be planted (i.e. should the MC curve not be downwards-sloping for quite a while) since you already have the provision for the tree school - you need one tree expert for 10 trees, and you still just need one for 100 trees? Maybe at a later stage, the MC will slope upwards again, as a new tree school would have to be opened with the capital outlay that this requires? So in my view the MC should be like a wave of some sort? Do we have any actual data on this?(17 votes)
Hi,
You are thinking of the MC in terms of accounting. Marginal cost refers to the marginal opportunity cost. An opportunity cost is the cost of the next highest valued alternative you give up. As you plant more and more trees, your opportunity cost increases. For instance, you have less time to do something else e.g. planting plants, doing your homework. Spending 100 hours to plant trees is not going to be as costly as compared to spending 1000 hours!(26 votes)
- How do I know whether to add an externality to the demand curve or the supply curve? In the previous videos dealing with negatives a new supply curve was created to find the equilibrium but in this a new demand curve was created. Since they have different outcomes, which would I use?(12 votes)
- I thought there were four types of externalities: negative externalities of production/consumption, and positive externalities of production and consumption.
In negative externality of production, MSC (marginal social cost) is higher than MPC (marginal private cost) so there is welfare loss. Which means that there is more cost to the society than to the firms in terms of production. Ex. paint factory
In negative externality of consumption, MPB (marginal private benefit) is higher than MSB (marginal social benefit) so there is welfare loss. Which means there is lesser benefit to the society than to private firms in terms of consumption. Ex. cigarette
In positive externality of production, MPC is higher than MSC. Which means that the society (government) can pay less than the firms in terms of production. So there is potential welfare gain. Ex. training provided by firms
In positive externality of consumption, MSB is higher than MPB which means that the society has more benefit than the firms in terms of consumption. So there is potential welfare gain. Ex. health care, education.(8 votes)
- Why does the consumer receive the society surplus from the subsidy. Also will the subsidy shift the supply curve to the right?(8 votes)
The consumer receives the surplus because society is willing to give a $10 tax credit (lower taxes) to get their positive externality. Even though the consumers might not think of this positive externality as a surplus, the $10 tax credit is benefit (surplus) to them.
The subsidy will not shift it to the right because only the consumers benefit from the tax credit. It doesn't change anything in the cost-structure of the producer.(5 votes)
- what is the example of negative externalities of technology spillover, industrial policy, and patent protection(5 votes)
- Hard too say. The thing is with this model, it doesn't matter what the external effect is as it is just measured as a number 'X'.
Your examples are quite interesting and even though we can't interpret them in this model, they could affect supply/demand in different markets (for instance labor).(4 votes)
- But if the government does subsidy, it has to actually pay the area of the rectangle with length 3.5 million (the new number of plants) and height 10 dollars/plant. That's an area of $35m just to not lose a VERY smaller area worth of positive deadweight.
It seems fairly inefficient.I mean the money could be spent in a more direct way.(5 votes)- That is the actual work of government to tax the negative influence'rs and benefit the do good'rs from those amounts received in taxes (the passing on the good can be direct on indirect) In a perfect Capitalist this will be not the case. The government acts as a socialist and bring about a semblance between the allocation of scarce resources availabel(2 votes)
Is Total Surplus the same as Total Revenue? Or is it the surplus of the revenue?(2 votes)- Consumer surplus is the difference between how much the consumer values the item and what they have to pay for it.
Total revenue is what the consumer pays (price) x how much is sold (quantity).
On a graph the TR will be a rectangle and the CS will be the triangle above the rectangle. These areas will not cover each other.
The producer surplus is the difference between the price and the lowest value that the producer would be willing to sell at, this will also be shown as a triangle on a graph but unlike CS it will always be within the TR rectangle.
Total Surplus is the combination of CS an PS. Both TS and TR can be shown on the same graph however they will be different areas and are not the same thing.(4 votes)
- What determines a positive externality? Research, as in the case of trees, could be indisputable. However, there was a tax credit for hybrid cars. Some research argued that to manufacture a hybrid car (plus added costs of batteries to the consumer) was as efficient as a non-hybrid vehicle. Why, therefore, was there a government tax credit for hybrid cars? What determined the implementation of it? Economics or politics?(3 votes)
Hybrid cars are supposed to pollute less and get better gas mileage. So some positive benefits to American society might include cleaner air, cheaper healthcare, people running out of gas less often, which might reduce auto insurance rates, and even something like less American foreign aid being sent to Middle Eastern oil countries.(2 votes)
- In the lecture of negative externalities, to solve the problem of deadweight loss in graph, we impose tax on the product. But in this case, positive externalities, you said we can give some subsidies to people. So, is it right that imposing taxes in case of negative ext-, and subsidizing people in case of positive ext-?(3 votes)
You wouldn't subsidize people, you would subsidize the firm.(2 votes)
- Does that $10 tax credit occur for every unit between 0 and 3.3 million? Or, does it occur for every unit after 2.7 million?(2 votes)
- it occurs between 0 and 3.3(3 votes)
Video transcript
let's think about the market for a
certain type of bush or a certain type of tree that people can plant in their
gardens and here's our quantity of that tree planted planted each year 1 million
2 million maybe this is nationwide these are fairly large numbers for a
particular type of tree 4 million and so forth and so on and then here let me put
the price so this is the quantity quantity per year per year planted
planted in our country and over here this is going to be our dollars per tree
dollars per tree and maybe this is ten dollars this is 20 this is 30 this is 40
and our marginal cost curve for our supply curve would look just to even get
that first tree planted to get someone to to plant it and grow it and then
replant it in your garden you're gonna have to pay them at least ten dollars
and then each incremental tree is going to get a little bit more expensive and
so our marginal cost curve will look something like that
that's our marginal cost or supply curve and then our demand curve that very
first tree someone's going to get a huge benefit from it and then each
incremental tree people might get a little bit lower and lower benefit so it
might look something like this our demand curve would look like that demand
and this is the market for a certain nice tree nice tree and just let the if
you just let the market happen the way it's happening right over here we get to
a very natural equilibrium quantity it looks like it's about 2.7 million trees
planted per year and our equilibrium price is about $20 per tree and we
generate we generate all of this total surplus that's that split essentially
between the consumers the people who are buying the trees and the people who are
producing the trees now let's say that a research study comes out and this
particular breed of trees the nice tree it turns out has all of these benefits
to it so let's say that it's it does it has you know some it's somehow related
to pest control maybe all the pests that people don't like when they eat this
bark they go away or something that the mosquitos go away and you know
do you get less disease let's say it also improves air quality air quality
and let's say on top of that it's just it's just nice-looking so you know even
even if it's not your tree you pass it by in a neighborhood it just calms your
nerves and makes you feel better about the world so they are just nice nice to
look at to look at and this study that these researchers conduct they
determined that the benefit of all of these things of the pest control and the
air quality and the just the aesthetic benefit of society at large comes out
over the life of a tree to ten dollars a tree so it is ten dollars ten dollars
per tree per tree benefit so the is essentially saying that above and beyond
the benefit that the owner of the garden gets there's a societal there's an
external benefit and so you can imagine we're now talking about positive
externalities there's an external benefit of planting the tree that
amounts to ten dollars per tree so how would we factor that in how do we
determine if just right just given this equilibrium price and quantity whether
we we really are we do really have the optimal number of trees in society well
in the past we in the last few videos we had a negative externality we had a
external cost and so we added that cost to the cost curve now we have an
external benefit we have a positive externality so we can add this this
benefit to the marginal benefit curve so essentially this is the benefit that the
buyers of the tree are getting and to that let's add the benefit that society
is getting so society is getting ten dollars more benefit so this for
millions a tree or it's actually a little bit lower looks like it's about
three and a half million three there's ten dollars of benefit but if you
combine it with society's benefit so another ten dollars you would get up
here and so you would essentially and this first tree it looks like it's
almost fifty dollars of benefit but if you add society's benefit it's actually
closer to 60 dollars a benefit and so you're essentially taking this demand
curve and you're shifting it up by ten dollars when you are factoring in the
benefit when you are factoring in the benefit to society
so that up there and you could call this you could call this the marginal benefit
plus the external plus the external benefit curve so it's factoring in all
of the the benefit that society is getting by these trees planted but when
you look at that curve you get a slightly different equilibrium price you
get a slightly different equilibrium price the equilibrium price goes all the
way out here so now the equilibrium pressure goes up to this the equilibrium
price looks closer instead of $20 at $27 and the quantity the quantity actually
produced looks closer to 3.3 million and so if we just let the market happen
without factoring in this benefit in some way we're essentially leaving all
the table leaving on the table all of this all of the surplus that could have
happened if we just let the market settle in on its on it's natural price
in equilibrium and equilibrium quantity equilibrium price and equilibrium
quantity we're going to produce this 2.7 million and so the total benefit to
society is going to be this whole curve right or you can say society's benefit
is going to be this right over here the consumers benefit is going to be is
going to be this part right over here and then actually this part all the way
over here because our equilibrium prices gets right over there and then the
producers surplus is this is that right over there but we're leaving some
societal benefit on the table we are leaving if you think of it from
society's point of view you can view this orange area as a deadweight loss
we're leaving that on the table if we don't somehow create an incentive for
more of these trees to be produced and so in this situation a way to make the
optimal quantity produce in order for society to get this surplus what they
could do is in the case of a negative externality we imposed a tax that
factors in the negative externality now we could put some type of a subsidy we
could say hey if you plant a tree if if someone plants a tree plants a tree buys
and plants one of these trees you will get a $10 tax credit $10 tax credit so
it's essentially saying whoever plants one of these trees their taxes are going
to be $10 lower than what they would have
otherwise had paid and so essentially they're saying look whatever benefit you
were going to get from the tree we're going to give you ten dollars more
benefit for that and so you're essentially you're essentially making
sure that the optimal quantity is being produced now in that circumstance you're
essentially giving all of the marginal benefit that extra $10 benefit you're
giving it you're giving it to the people who are planting the trees so
essentially all of this all of this becomes their benefit as well because
they are going to get the ten dollars but the good thing is at least at least
that positive surplus is getting is going to someone it's not being lost
you're not giving up you're not giving up on this orange area right over there