Externalities can be good too. The logic of Negative Externalities runs in reverse when a benefit spills onto bystanders.
Key idea
A positive externality is a benefit to bystanders: a flu shot protects the people around you, and research by one firm helps others. When the benefit comes from using the good, the marginal social benefit is $MSB = MPB + MEB$, a curve above demand. The market produces where demand (private benefit) meets supply, less than the efficient quantity where MSB meets supply. The deadweight loss is the triangle between MSB and supply, from the market quantity to the efficient quantity.
Why it works
Buyers compare the price with their own benefit. The protection their flu shot gives coworkers doesn't enter that decision, so they buy as if it were zero. Units between the market quantity and the efficient quantity are worth more to society (buyer plus bystanders) than they cost to make, but no one buys them. When the spillover comes from producing a good, as when a beekeeper's bees pollinate nearby orchards, the external benefit lowers the social cost instead: the social cost curve lies below supply.
Worked example: Flu shots
At a clinic, private demand for flu shots is $P = 40 - Q$ (Q in shots a day), supply is $P = 10 + Q$, and each shot gives other people \$10 of protection. Find the market and efficient quantities and the deadweight loss.
- Market: $40 - Q = 10 + Q$, so $Q_m = 15$.
- $MSB = 50 - Q$. Efficient: $50 - Q = 10 + Q$, so $Q_e = 20$.
- At $Q_m = 15$ the gap is $(50 - 15) - (10 + 15) = 10$.
- $DWL = \tfrac{1}{2} \times 10 \times (20 - 15) = \$25$ a day.
Answer: Market 15, efficient 20 shots a day; DWL \$25 a day.
Worked example: Which side?
A homeowner's flower garden pleases the neighbors. Where does the external benefit go on the graph of gardening?
- The benefit comes from the garden existing, which is the homeowner's consumption choice.
- It adds to the benefit side: MSB lies above the homeowner's demand.
Answer: On the benefit side, above demand.
Common mistake
Drawing a benefit from consuming a good on the supply side. A flu shot's spillover comes from people using it, so it raises the social benefit curve above demand; supply doesn't change. Check: ask "does the spillover come from buying and using, or from producing?" and draw it on that side.