<POSITIVE EXTERNALITY OF CONSUMPTION>

• If you knew that every time you GOT GOOD ECONOMICS GRADES you were BENEFITING MR. BOUNOUS BY BOOSTING HIS LOW SELF-ESTEEM and ALSO IMPROVING HIS FUTURE JOB PROSPECTS would you be incentivised to study harder? NO!!!!

• What if Mr. Bounous thanked you or even paid you? MAYBE!!!!

• Clearly, the quantity of STUDY/EDUCATION/LEARNING consumed for your OWN BENEFIT is less than the quantity desired by YOU + Mr. Bounous.

• So we can summise that there is a PRIVATE DEMAND CURVE as well as  SECOND CURVE, representing SOCIETY'S DEMAND right? 

• A POSITIVE EXTERNALITY OF CONSUMPTION occurs when an INDIVIDUAL'S CONSUMPTION of a GOOD or SERVICE increases the well-being (CREATES EXTERNAL BENEFITS) of others (THIRD PARTIES) but the individual is NOT COMPENSATED by those others.

• These type of goods/servces are referred to as 'MERIT GOODS'.

• There are basically TWO REASONS why MERIT GOODS are UNDERCONSUMED:-

• • • FIRSTLY, if the CONSUMERS are not COMPENSATED (REIMBURSED) for the EXTERNAL BENEFITS that they create for others then the PRICE THEY ARE WILLING TO PAY will be LOWER than the socially optimal price therefore, they will DEMAND LESS at each price level ('UNDERCONSUME'), which will result in less quantity transacted and consumed.

• • • SECONDLY, because the CONSUMER is OFTEN IGNORANT (UNAWARE) about the overall benefits of consuming products such as HEALTH CHECK-UPS, or EXTRA TUITION etc, their DEMAND is LOW.

• If in THE PROCESS OF CONSUMING a good, there are EXTERNAL BENEFITS to third parties (IN THE FORM OF COST SAVINGS) that the consumer is NOT COMPENSATED (REIMBURSED) FOR then the PRICE that THEY ARE WILLING TO PAY (as represented by the MARGINAL PRIVATE BENEFIT (MPB) they receive) will be LOWER than the SOCIALLY OPTIMUM  PRICE which is based on MARGINAL SOCIAL BENEFIT (MSB) which is equal to MARGINAL PRIVATE BENEFIT + EXTERNAL BENEFITS.

• In other words, if we based the demand curve on the marginal price society is willing to pay per unit (as represented by MARGINAL PRIVATE BENEFIT + EXTERNAL BENEFITS they expect to receive per unit) rather than the marginal price private individual consumers are willing to pay per unit (as represented by the marginal private benefit they expect to receive) we will derive TWO DEMAND CURVES, one representing society (MSB CURVE) and one representing the private consumers (MPB CURVE) with the MSB curve more to the RIGHT.

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

• Hence the free market output is LESS THAN the socially optimal amount (MSB = MSC).

• We can see in the diagram below, that the EXCLUSION of EXTERNAL BENEFITS results in the consumer's demand curve (MPB) being to the LEFT, of the MSB curve, (MPB<MSB) leading to UNDERCONSUMPTION and a DWL.

• An individual student's demand curve for education represents their own MARGINAL PRIVATE BENEFIT (MPB) that they expect to receive from CONSUMING each additional unit of education.

• However, the impact of EDUCATION creates EXTERNAL BENEFITS to 3rd parties (SOCIETY) such as GREATER PRODUCTIVITY, HIGHER GDP, GREATER INNOVATION, HIGHER GOV'T TAX REVENUES TO SPEND ON MERIT GOODS etc... yet in a free-market the student DOES NOT RECEIVE ANY COMPENSATION from society.

• If this external benefit was to be returned to the consumer then the final price of education would be lower and more would be consumed and we would arrive at the SOCIALLY OPTIMAL LEVEL (Closer to the MSB curve). 

• An individual patient's demand curve for vaccinations against infectious diseases represents their own MARGINAL PRIVATE BENEFIT (MPB) that they expect to receive from CONSUMING each additional unit of the flu vaccination.

• However, the impact of MORE VACCINATED PEOPLE creates EXTERNAL BENEFITS to 3rd parties (SOCIETY) as immediately there is one fewer potential carrier of infectious diseases to catch it from, and a healthier workforce and society benefits everyone. Yet in a free market the patient DOES NOT RECEIVE ANY COMPENSATION from society.

• If this external benefit was to be returned to the consumer then the final price of vaccinations would be lower and more would be consumed and we would arrive at the SOCIALLY OPTIMAL LEVEL (Closer to the MSB curve). 

Explain why the market for ELECTRIC VEHICLES (EVs) IS NOT an example of a MERIT GOOD being underprovided.

• The government could make it COMPULSORY for consumers to purchase a good, such as COMPULSORY EDUCATION, MANDATED VACCINATIONS, FACE MASKS, BICYCLE HELMETS, and ELECTRIC CARS...

• These actions would INCREASE DEMAND and SHIFT THE MPB CUREV TO THE RIGHT closer to the MSB

• The government can use ADVERTISING & EDUCATION to INFORM consumers about the benefits of having GOOD EDUCATION, VACCINATIONS, EATING HEALTHY etc... 

• This way demand will increase and the MPB CURVE will SHIFT RIGHTWARDS.

• DIRECT GOVERNMENT PROVISION, would result in GREATER SUPPLY, which would SHIFT THE MPC CURVE TO THE RIGHT which in turn would LOWER THE PRICE, resulting in MOVEMENT DOWN THE MPB CURVE.

• SUBSIDIES will LOWER THE FIRM'S COSTS OF PRODUCTION allowing them to LOWER THE PRICE of the good, leading to a MOVEMENT DOWN THE MPB curve and an increase in the quantity demanded, ideally to the socially optimal level.

• SUBSIDIES that come in the form of a REIMBURSEMENT AFTER PURCHASE are called 'REBATES'. In this case the subsidy has NO IMPACT ON THE COSTS OF PRODUCTION of the supplier, as such their MPC curve stays the same as does the selling price to consumers.

• However, as a portion of this expenditure is refunded to consumers it effectively lowers the price of the product leading an INCREASE IN QUANTITY DEMANDED, and a MOVEMENT DOWN THE MPB curve closer to the QSO.

Explain why an EV subsidy is actually a policy to reduce the overconsumption of a demerit good.

• COPY & PASTE one of the 2 example explanations above, then EDIT it using MTR EXPANSION as the example. (Include the definitions and diagram w. explanation)

• HINT: What are the external benefits of people using the MTR (public transport), rather than driving?

Using the explanations above can you explain why the market for electric cars IS NOT an example of the UNDERCONSUMPTION OF A MERIT GOOD

--READ THE FOLLOWING, DO YOU AGREE THAT GREATER CONSUMPTION OF EV CARS CREATES EXTERNAL BENEFITS?--

• An individual consumer's demand curve for EVs represents their own MARGINAL PRIVATE BENEFIT (MPB) that they expect to receive from CONSUMING each additional unit of the EV.

• However, the impact of MORE ELECTRIC VEHICLES creates EXTERNAL BENEFITS to 3rd parties (SOCIETY) as immediately there is one fewer petrol-powered car to add to pollution levels and hence there is a reduction in all pollution-related side-effects on society*. Yet in a free market the EV consumer DOES NOT RECEIVE ANY COMPENSATION from society.

• If this external benefit was to be returned to the consumer then the final price of EVs would be lower and more would be consumed and we would arrive at the SOCIALLY OPTIMAL LEVEL (Closer to the MSB curve).

• * Note, even though driving an EV itself does not emit EXTERNAL BENEFITS it results in the reduction in EXTERNAL COSTS created when driving the alternative petrol cars.