Positive Consumption Externalities

Analysis of positive consumption externalities as a cause of market failure is covered in this topic revision video.

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

Externalities cause market failure if the price mechanism does not take account of the social costs and benefits of production and consumption

What are Positive Consumption Externalities?

• A positive consumption externality occurs when consuming a good cause a positive spillover to a third party lying outside the transaction.
• This means that the social benefits of consumption exceed the private benefits
• The social marginal benefit curve (SMB) is drawn higher 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

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 level.