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Positive Externalities & Failure


Why do positive externalities lead to a failure of the normal free-market mechanism?   Where substantial positive externalities exist, the good or service may be under consumed or under provided since the free market may fail to take into account their effects. This is because the marginal social benefits of consuming the good > private marginal benefits.


In the case of external benefits from production, the marginal social cost would be  private marginal costs. Consider the example of health care. Good quality health care brings positive spillover effects both for the recipient of the care but also their families and associates. A well functioning health care system also reduces the scale of absenteeism from work due to sickness and illness. We see in the diagram above how the provision and consumption of health care services leads to an increase in social benefits and a reduction in social costs. As a society we should be encouraging people to increase their consumption of health care services.





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