Positive consumption externalities

This revision study note covers positive consumption externalities.

Externalities are spill-over effects from production and/or consumption for which no appropriate compensation is paid to one or more third parties affected. Externalities lie outside the initial market transaction / and are not reflected in the market price.

Positive Consumption Externalities

• A positive consumption externality occurs when consuming a good cause a positive externality to a third party.
• This means that the social benefits of consumption exceed the private benefits
• The social marginal benefit curve (SMB) is greater than private marginal benefit (PMB)
• In a free market without government intervention there will be under-consumption of goods with positive consumption externalities
• This leads to market failure

Positive consumption externalities – analysis diagram

If the market price ignores positive externalities, then there will be under-consumption

Key takeaway points:

• Discussion of what constitutes a positive consumption externality can involve making value judgements
• There are potentially large social welfare gains from government interventions designed to increase take-up / consumption of goods and services with positive externalities
• Effective behavioural nudges might help to increase consumption towards a social optimum