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Other examples of positive externalities

Although technology may be the most prominent example of a positive externality, it is not the only one. For example, being vaccinated against disease is not only a protection for the individual, but it has the positive spillover of protecting others who may become infected. When a number of homes in a neighborhood are modernized, updated, and restored, not only does it increase the value of those homes, but the value of other properties in the neighborhood may increase as well.

The appropriate public policy response to a positive externality, like a new technology, is to help the party creating the positive externality receive a greater share of the social benefits. In the case of vaccines, like flu shots, an effective policy might be to provide a subsidy to those who choose to get vaccinated.

[link] shows the market for flu shots. The market demand curve D Market for flu shots reflects only the marginal private benefits (MPB) that the vaccinated individuals receive from the shots. Assuming that there are no spillover costs in the production of flu shots, the market supply curve is given by the marginal private cost (MPC) of producing the vaccinations.

The equilibrium quantity of flu shots produced in the market, where MPB is equal to MPC, is Q Market and the price of flu shots is P Market . However, spillover benefits exist in this market because others, those who chose not to purchase a flu shot, receive a positive externality in a reduced chance of contracting the flu. When we add the spillover benefits to the marginal private benefit of flu shots, the marginal social benefit (MSB) of flu shots is given by D Social . Because the MPB is greater than MSB, we see that the socially optimal level of flu shots is greater than the market quantity (Q Social exceeds Q Market ) and the corresponding price of flu shots, if the market were to produce Q Social , would be at P Social . Unfortunately, the marketplace does not recognize the positive externality and flu shots will go under produced and under consumed.

So how can government try to move the market level of output closer to the socially desirable level of output? One policy would be to provide a subsidy, like a voucher, to any citizen who wishes to get vaccinated. This voucher would act as “income” that could be used to purchase only a flu shot and, if the voucher was exactly equal to the per-unit spillover benefits, would increase market equilibrium to a quantity of Q Social and a price of P Social where MSB equals MSC. Suppliers of the flu shots would receive payment of P Social per vaccination, while consumers of flu shots would redeem the voucher and only pay a price of P Subsidy . When the government uses a subsidy in this way, the socially optimal quantity of vaccinations is produced.

The market for flu shots with spillover benefits (a positive externality)

The graph shows the market for flu shots: flu shots will go under produced because the market does not recognize their positive externality. If the government provides a subsidy to consumers of flu shots, equal to the marginal social benefit minus the marginal private benefit, the level of vaccinations can increase to the socially optimal quantity of QSocial.
The market demand curve does not reflect the positive externality of flu vaccinations, so only Q Market will be exchanged. This outcome is inefficient because the marginal social benefit exceeds the marginal social cost. If the government provides a subsidy to consumers of flu shots, equal to the marginal social benefit minus the marginal private benefit, the level of vaccinations can increase to the socially optimal quantity of Q Social .

Key concepts and summary

Competition creates pressure to innovate. However, if new inventions can be easily copied, then the original inventor loses the incentive to invest further in research and development. New technology often has positive externalities; that is, there are often spillovers from the invention of new technology that benefit firms other than the innovator. The social benefit of an invention, once these spillovers are taken into account, typically exceeds the private benefit to the inventor. If inventors could receive a greater share of the broader social benefits for their work, they would have a greater incentive to seek out new inventions.


HighFlyer Airlines wants to build new airplanes with greatly increased cabin space. This will allow HighFlyer Airlines to give passengers more comfort and sell more tickets at a higher price. However, redesigning the cabin means rethinking many other elements of the airplane as well, like the placement of engines and luggage, and the most efficient shape of the plane for moving through the air. HighFlyer Airlines has developed a list of possible methods to increase cabin space, along with estimates of how these approaches would affect costs of operating the plane and sales of airline tickets. Based on these estimates, [link] shows the value of R&D projects that provide at least a certain private rate of return. Column 1 = Private Rate of Return. Column 2 = Value of R&D Projects that Return at Least the Private Rate of Return to HighFlyer Airlines. Use the data to answer the following questions.

Private Rate of Return Value of R&D
12% $100
10% $200
8% $300
6% $400
4% $500
  1. If the opportunity cost of financial capital for HighFlyer Airlines is 6%, how much should the firm invest in R&D?
  2. Assume that the social rate of return for R&D is an additional 2% on top of the private return; that is, an R&D investment that had a 7% private return to HighFlyer Airlines would have a 9% social return. How much investment is socially optimal at the 6% interest rate?
Got questions? Get instant answers now!


Arias, Omar and Walter W. McMahon. “Dynamic Rates of Return to Education in the U.S.” Economics of Education Review . 20, 2001. 121–138.

Biography.com. 2015. “Alan Turing.” Accessed April 1, 2015. http://www.biography.com/people/alan-turing-9512017.

Canty Media. 2015. “The World: Life Expectancy (2015) - Top 100+.” Accessed April 1, 2015. http://www.geoba.se/population.php?pc=world&type=15.

Hyclak, Thomas, Geraint Johnes, and Robert Thornton. Fundamentals of Labor Economics. Boston: Houghton Mifflin Company, 2005.

McMahon, Walter. Education and Development: Measuring the Social Benefits. Oxford: Oxford University Press, 2000.

National Institute of Health. 2015. “Global Competitiveness—The Importance of U.S. Leadership in Science and Innovation for the Future of Our Economy and Our Health.” Accessed April 1, 2015. http://www.nih.gov/about/impact/impact_global.pdf.

National Science Foundation. 2013. “U.S. R&D Spending Resumes Growth in 2010 and 2011 but Still Lags Behind the Pace of Expansion of the National Economy.” Accessed April 1, 2015. http://www.nsf.gov/statistics/infbrief/nsf13313/.

Psacharopoulos, George. “Returns to Investment in Education: A Global Update.” World Development 22, 1994. 1325–1343.

Salientes-Narisma, Corrie. “Samsung Shift to Innovative Devices Pay Off.” Inquirer Technology . Accessed May 15, 2013. http://technology.inquirer.net/23831/samsungs-shift-to-innovative-devices-pays-off.

Questions & Answers

what is the meaning of function in economics
Effah Reply
Pls, I need more explanation on price Elasticity of Supply
Isaac Reply
Is the degree to the degree of responsiveness of a change in quantity supplied of goods to a change in price
Discuss the short-term and long-term balance positions of the firm in the monopoly market?
Rabindranath Reply
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what is firms
Anteyi Reply
A firm is a business entity which engages in the production of goods and aimed at making profit.
What is autarky in Economics.
what is choice
Tia Reply
So how is the perfect competition different from others
Rev Reply
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The short run is a period of time in which the quantity of at least one inputs is fixed...
that is the answer that I found online and in my text book
Meaning of economics
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It will creates rooms for an effective demands.
Chinedum Reply
different between production and supply
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Economics is a science which study human behavior as a relationship between ends and scarce means which has an alternative use.
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Debless Reply
Demand refers to the quantity of products that consumers are willing to purchase at various prices per time while Supply has to do with the quantity of products suppliers are willing to supply at various prices per time. find the difference in between
Please what are the effects of rationing Effect of black market Effects of hoarding
Atty Reply
monoply is amarket structure charecrized by asingle seller and produce a unique product in the market
Cali Reply
I want to know wen does the demand curve shift to the right
demand curve shifts to the right when there's an increase in price of a substitute or increase in income
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explain the law of supply in simple .....
the Law of supply: states that all factor being equal, when the price of a particular goods increase the supply will also increase, as it decreases the supply will also decrease
@Nana the factor that changes or shift the d demand curve to the right is 1) the increase in price of a substitute good or commodity 2) increase in income
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define an apportunity cost?
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In a simple term, it is an Alternative foregone.
opportunity cost is the next best value of a scale of preference
Both of you are not correct.
opportunity cost: is a forgone alternative
Monopoly is where is one producer produces a given product with no close substitute
what is income effect?
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