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.