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Other examples of positive externalities

Although technology may be the most prominent example of a positive externality, it is not the only one. For example, being vaccinated against disease is not only a protection for the individual, but it has the positive spillover of protecting others who may become infected. When a number of homes in a neighborhood are modernized, updated, and restored, not only does it increase the value of those homes, but the value of other properties in the neighborhood may increase as well.

The appropriate public policy response to a positive externality, like a new technology, is to help the party creating the positive externality receive a greater share of the social benefits. In the case of vaccines, like flu shots, an effective policy might be to provide a subsidy to those who choose to get vaccinated.

[link] shows the market for flu shots. The market demand curve D Market for flu shots reflects only the marginal private benefits (MPB) that the vaccinated individuals receive from the shots. Assuming that there are no spillover costs in the production of flu shots, the market supply curve is given by the marginal private cost (MPC) of producing the vaccinations.

The equilibrium quantity of flu shots produced in the market, where MPB is equal to MPC, is Q Market and the price of flu shots is P Market . However, spillover benefits exist in this market because others, those who chose not to purchase a flu shot, receive a positive externality in a reduced chance of contracting the flu. When we add the spillover benefits to the marginal private benefit of flu shots, the marginal social benefit (MSB) of flu shots is given by D Social . Because the MPB is greater than MSB, we see that the socially optimal level of flu shots is greater than the market quantity (Q Social exceeds Q Market ) and the corresponding price of flu shots, if the market were to produce Q Social , would be at P Social . Unfortunately, the marketplace does not recognize the positive externality and flu shots will go under produced and under consumed.

So how can government try to move the market level of output closer to the socially desirable level of output? One policy would be to provide a subsidy, like a voucher, to any citizen who wishes to get vaccinated. This voucher would act as “income” that could be used to purchase only a flu shot and, if the voucher was exactly equal to the per-unit spillover benefits, would increase market equilibrium to a quantity of Q Social and a price of P Social where MSB equals MSC. Suppliers of the flu shots would receive payment of P Social per vaccination, while consumers of flu shots would redeem the voucher and only pay a price of P Subsidy . When the government uses a subsidy in this way, the socially optimal quantity of vaccinations is produced.

The market for flu shots with spillover benefits (a positive externality)

The graph shows the market for flu shots: flu shots will go under produced because the market does not recognize their positive externality. If the government provides a subsidy to consumers of flu shots, equal to the marginal social benefit minus the marginal private benefit, the level of vaccinations can increase to the socially optimal quantity of QSocial.
The market demand curve does not reflect the positive externality of flu vaccinations, so only Q Market will be exchanged. This outcome is inefficient because the marginal social benefit exceeds the marginal social cost. If the government provides a subsidy to consumers of flu shots, equal to the marginal social benefit minus the marginal private benefit, the level of vaccinations can increase to the socially optimal quantity of Q Social .

Key concepts and summary

Competition creates pressure to innovate. However, if new inventions can be easily copied, then the original inventor loses the incentive to invest further in research and development. New technology often has positive externalities; that is, there are often spillovers from the invention of new technology that benefit firms other than the innovator. The social benefit of an invention, once these spillovers are taken into account, typically exceeds the private benefit to the inventor. If inventors could receive a greater share of the broader social benefits for their work, they would have a greater incentive to seek out new inventions.


HighFlyer Airlines wants to build new airplanes with greatly increased cabin space. This will allow HighFlyer Airlines to give passengers more comfort and sell more tickets at a higher price. However, redesigning the cabin means rethinking many other elements of the airplane as well, like the placement of engines and luggage, and the most efficient shape of the plane for moving through the air. HighFlyer Airlines has developed a list of possible methods to increase cabin space, along with estimates of how these approaches would affect costs of operating the plane and sales of airline tickets. Based on these estimates, [link] shows the value of R&D projects that provide at least a certain private rate of return. Column 1 = Private Rate of Return. Column 2 = Value of R&D Projects that Return at Least the Private Rate of Return to HighFlyer Airlines. Use the data to answer the following questions.

Private Rate of Return Value of R&D
12% $100
10% $200
8% $300
6% $400
4% $500
  1. If the opportunity cost of financial capital for HighFlyer Airlines is 6%, how much should the firm invest in R&D?
  2. Assume that the social rate of return for R&D is an additional 2% on top of the private return; that is, an R&D investment that had a 7% private return to HighFlyer Airlines would have a 9% social return. How much investment is socially optimal at the 6% interest rate?
Got questions? Get instant answers now!


Arias, Omar and Walter W. McMahon. “Dynamic Rates of Return to Education in the U.S.” Economics of Education Review . 20, 2001. 121–138.

Biography.com. 2015. “Alan Turing.” Accessed April 1, 2015. http://www.biography.com/people/alan-turing-9512017.

Canty Media. 2015. “The World: Life Expectancy (2015) - Top 100+.” Accessed April 1, 2015. http://www.geoba.se/population.php?pc=world&type=15.

Hyclak, Thomas, Geraint Johnes, and Robert Thornton. Fundamentals of Labor Economics. Boston: Houghton Mifflin Company, 2005.

McMahon, Walter. Education and Development: Measuring the Social Benefits. Oxford: Oxford University Press, 2000.

National Institute of Health. 2015. “Global Competitiveness—The Importance of U.S. Leadership in Science and Innovation for the Future of Our Economy and Our Health.” Accessed April 1, 2015. http://www.nih.gov/about/impact/impact_global.pdf.

National Science Foundation. 2013. “U.S. R&D Spending Resumes Growth in 2010 and 2011 but Still Lags Behind the Pace of Expansion of the National Economy.” Accessed April 1, 2015. http://www.nsf.gov/statistics/infbrief/nsf13313/.

Psacharopoulos, George. “Returns to Investment in Education: A Global Update.” World Development 22, 1994. 1325–1343.

Salientes-Narisma, Corrie. “Samsung Shift to Innovative Devices Pay Off.” Inquirer Technology . Accessed May 15, 2013. http://technology.inquirer.net/23831/samsungs-shift-to-innovative-devices-pays-off.

Questions & Answers

please...when something like a factor of production varies in the long run, what does it mean..? And it's fixed in the short ry n, wat does it mean?
Enoch Reply
factor of production in long run calls variable factor and in short run calls fixed factor...
Ther r 2 types of factor of prod. 1.Variable 2. Fixed. during long run we can change both. but Short run only variable factor changes.
So land labour capital what is it
factors of production
Land is Fixed factor of production. Labour is Variable FoP
How can i get a quantity demand and supply?
Charlene Reply
i dont know
My name is Matthew
i don't know because i am new student of the BS ECONOMIC
please guide me
what is the question ? is it numerical ?
Do you mean the definition for quantity demand and supply or wat
what is Monopoly?
Nat Reply
Monopoly is a market structure which has only one seller or producer which do not have close subtitude
what is price mechanism
kobbina Reply
It is the economic means by which gov't, economic agencies, buyers and sellers determine the price to influence the demand and supply of a commodity.
price mechanism is the manner in which the prices of goods and services affect the supply and demand of goods and services.
accounts in balance of payment
Ikogor Reply
What is deadweight loss?
what is economics
Michael Reply
economics is. study about money and the human beings,the economics is social science
Economics is a science which studies humans behaviour between ends and scarce means.
the total amount of money earned within a country
abdul Reply
What is trade line
Ruchi Reply
what is scars
Siaw Reply
What is land as labour
Price and output determination in a monopoly?
Ruchi Reply
Monopoly :its features, measures market power
Monopoly is market structure where he/she is d boss with no competition.Therefore he quote his own price for product as well for quantity he provide. Eg.Suppose desert area only one shop he/she selling 10ltr water bottle @25.But with same amt you could have bought 20ltr if it's perfect competition.
Economics is a social sciences that have diverse application
Francis Reply
what is economics?
Osborne Reply
Economic is the study of human behaviour in relation with the scare resources and it alternate use.
Economics is a social sciences that have diverse application...
the branch of knowledge concerned with the production, consumption, and transfer of wealth.
choice and opportunity cost?
choice is the next best alternative
Choice is option available. Opportunity cost means giving up other to get The 1st one. eg. U r hungry u got 2option available on fridge A and B. You select A over B. so this is opportunity cost. B is the Opportunity Cost over A.
can I get simple language and examples?
Gajendra Reply

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