What Are Positive Externalities?

In this video, we explain positive externalities with a real-world example: influenza vaccines that help prevent the spread of the disease. Patients who get the shots bear all of the costs (monetary and otherwise), but society at large benefits from reduced transmission, preventing some people from getting the flu even if they weren’t vaccinated.

A few highlights from the video:

• The Definition of Positive Externalities. Externalities occur when a decision or a transaction between two parties also affects third parties (bystanders). A positive externality occurs when the transaction provides benefits to bystanders. Tidying up your yard is a classic example–the whole neighborhood enjoys the benefits of your property looking nicer.
• Graphing Positive Externalities. We can plot positive externalities on a supply and demand graph, using a new line for social value (above the demand curve by the amount of the external benefit). The social value curve intersects the supply curve at the socially optimal quantity.
• The Impact of Positive Externalities. The market underproduces a good with a positive externality relative to the efficient equilibrium. Society is worse off due to the undersupply, resulting in deadweight loss. At the efficient equilibrium, where the social benefit curve intersects the supply curve, social surplus—the sum of producer surplus, consumer surplus, and bystander surplus—is maximized.

Be sure to check out our other videos covering negative externalities, as well as public policy solutions to address externalities: Pigouvian taxes and subsidies, Coasean bargaining, tradable allowances, and command and control.