Before we move on, it is worth taking a moment to see that not all externalities are negative. It is possible for the benefit to society to be even higher than the benefit that an individual will receive when a transaction takes place. In this instance we will see a positive externality – a situation in which a good or service is actually being under-produced by the free market. In this case the government should intervene to try and increase the production of that good or service.
For example, consider what happens when one person is inoculated against influenza (the ‘flu). When that happens, the person who has received the injection is now far less likely to experience ‘flu like symptoms. In other words, they are less likely to get sick. This is a benefit to them, and so it makes sense that they would be happy to pay to participate in this transaction.
However, there are also side effects. Imagine for a moment that you came into contact with a person who could have been inoculated, but chose not to be. This person might have the ‘flu, and they might then pass it on to you. Clearly this is not desirable. In receiving the injection this person might avoid getting sick, and as a result you wouldn’t get sick either. This would happen even though you were not a party to the original transaction, and as such you will benefit from a positive externality.
This process will then flow through to other people. Those who might otherwise have caught the ‘flu from you now won’t, and so on. Each of these people benefited from the decision made by the original person.
As a result, the government will act to try and encourage the production and consumption of goods and services with positive externalities. Injections are generally heavily subsidised, and as a result more people can access them.
Positive externalities are not limited to medical practises. For example, when an employee receives training, it is possible for this to result in a positive externality. If they train others in the office in the same way, then those people have also benefited. If the employee moves on to a new position in a different company, they will take all of their skills with them. The new business can benefit from these skills even though they didn’t pay for the original training. The business has gained a positive externality.
You will learn more about market failure when you study Unit 3.
