<POSITIVE EXTERNALITY OF PRODUCTION>

If you knew that every time you WROTE OUT A MODEL ANSWER and ENTERED IT IN THE CLASS SHARED GOOGLE SHEET, it was also BENEFITING OTHER STUDENTS, would this encourage you to spend more of your precious time and produce more? What if those students who really benefitted from them paid (Compensated) you? Clearly, THE QUANTITY PRODUCED FOR YOUR OWN BENEFIT is LESS THAN THE QUANTITY DESIRED BY SOCIETY.

A POSITIVE EXTERNALITY OF PRODUCTION occurs when an INDIVIDUAL FIRM'S PRODUCTION ACTIVITY increases the well-being (CREATES EXTERNAL BENEFITS, often in the form of 'COST SAVINGS') of others (THIRD PARTIES) but the individual firm is NOT COMPENSATED by those others.

These ACTIVITIES are referred to as 'MERIT GOODS'.

There are basically TWO REASONS why MERIT GOODS are UNDERPRODUCED:-

• • FIRSTLY, if the firms are not COMPENSATED (REIMBURSED) for the EXTERNAL BENEFITS then their COSTS OF PRODUCTION will be HIGHER and therefore they will SUPPLY LESS ('UNDERPRODUCE'), AT HIGHER PRICES. In other words, their SUPPLY curve (MPC) will be below the socially optimal supply curve (MSC).

• • SECONDLY, because SOCIETY is OFTEN IGNORANT (UNAWARE) about the overall benefits of these products and therefore the DEMAND for them is too low.

If in THE PROCESS OF PRODUCING a good, there are EXTERNAL BENEFITS to third parties (IN THE FORM OF 'COST SAVINGS') that the producer is NOT COMPENSATED (REIMBURSED) FOR then their COSTS OF PRODUCTION will be HIGHER and therefore they will SUPPLY LESS ('UNDERPRODUCE'), AT a HIGHER PRICE.

In other words, the PRODUCER'S SUPPLY CURVE only represents their PRIVATE COSTS (MPC) and therefore will not represent society's cost curve (MSC) which is equal to the PRIVATE COST LESS THE EXTERNAL BENEFIT (COST-SAVING') of this activity on society meaning that the MPC curve will be below (to the right of) the socially optimal supply curve (MSC).

NOW IF WE ASSUME THE MSB CURVE IS FIXED then the equilibrium quantity transacted using the MSC curve is MORE THAN the equilibrium quantity transacted using the MPC curve.

Hence the FREE MARKET OUTPUT (MSB = MPC) is LESS THAN the SOCIALLY OPTIMAL AMOUNT (MSB = MSC), and the good is therefore UNDERPRODUCED.

We can see in the diagram below, that the exclusion of external costs results in the producer's supply curve (MPC) being to the RIGHT, of the MSC curve, (MPC<MSC) leading to OVERPRODUCTION and a DWL.

An individual producer's supply curve represents their own MARGINAL PRIVATE COSTS (MPC) including the training costs of its employees, however, this training also creates EXTERNAL BENEFITS to 3rd parties (SOCIETY) as FUTURE EMPLOYERS will NOT NEED TO PAY FOR TRAINING, also they will BENEFIT FROM THEIR GREATER PRODUCTIVITY etc yet in a free-market, the producer DOES NOT RECEIVE ANY COMPENSATION from THE FUTURE EMPLOYERS.

Clearly, if they knew that they would receive compensation in the future from other firms then they would be more willing to pay for more training now.

If this external benefit was to be returned to the producer then their final costs of production would be lower and their MPC curve would be further to the RIGHT and more would be consumed and we would arrive at the SOCIALLY OPTIMAL LEVEL (Closer to the MSC curve). 

COPY & PASTE the explanation related to 'JOB TRAINING' above, then EDIT it using IB TRAINING as the example. (Include the definitions and diagram w. explanation)

An individual producer's supply curve represents their own MARGINAL PRIVATE COSTS (MPC) including their EXPENDITURE ON RESEARCH & DEVELOPMENT, however, this research also creates EXTERNAL BENEFITS to 3rd parties (SOCIETY) as SCIENTIFIC BREAKTHROUGHS such as VACCINES to PANDEMICS not only ENSURE PROTECTION but also allow HAVE 'SPILLOVER BENEFITS' only made possible by these findings and so on. In addition, PATENTS EXPIRE and all the discoveries will be FREELY AVAILABLE eventually. yet in a free-market, the producer DOES NOT RECEIVE ANY COMPENSATION from society and hence conducts less R & D, than desirable.

If this external benefit was to be returned to the producer then their final costs of production would be lower and their MPC curve would be further to the RIGHT and more would be consumed and we would arrive at the SOCIALLY OPTIMAL LEVEL (Closer to the MSC curve). 

The Land Authority's supply curve represents their own MARGINAL PRIVATE COSTS (MPC) including the costs of constructing roads and bridges, paying workers wages, etc, however, this production process also creates EXTERNAL BENEFITS to 3rd parties (SOCIETY) for example IT CREATES EXTERNAL BENEFITS for many local firms, who will now likely have MORE CUSTOMERS, while the VALUE OF THEIR PROPERTIES WILL ALSO RISE, yet in a free market, the Land authority DOES NOT RECEIVE ANY COMPENSATION from society.

If this external benefit was to be returned to the Land Authority then their final costs of production would be lower and their MPC curve would be further to the RIGHT and more would be produced and we would arrive at the SOCIALLY OPTIMAL LEVEL (Closer to the MSC curve).  

An individual beekeeper's supply curve represents their own MARGINAL PRIVATE COSTS (MPC) including the costs of maintaining their hives etc, however, this production process also creates EXTERNAL BENEFITS to 3rd parties (SOCIETY) in particular NEARBY FARMERS BENEFIT FROM THE BEES POLLINATING their crops/plants... yet in a free-market, the beekeeper DOES NOT RECEIVE ANY COMPENSATION from society.

If this external benefit was to be returned to the beekeeper then their final costs of production would be lower and their MPC curve would be further to the RIGHT and more would be consumed and we would arrive at the SOCIALLY OPTIMAL LEVEL (Closer to the MSC curve).  

COPY & PASTE one of the four example explanations above, then EDIT it using QATAR 2022 as the example. (Include the definitions and diagram w. explanation)

GOVERNMENT can engage in R&D itself.

GOVERNMENT can directly provide training itself. 

GOVERNMENT can subsidise private firms to conduct the R&D.

GOVERNMENT can subsidise private firms to provide training.