Positive Externality of Production
A diagram illustrating a positive externality of production, where the marginal social cost (MSC) is lower than the marginal private cost (MPC), leading to underproduction and welfare loss.
demand
Demand Curve (MPB = MSB): Represents marginal private and social benefit, assuming no externalities in consumption.
mpc
MPC (S): Marginal private cost — the cost borne by producers.
msc
MSC: Marginal social cost — the lower true cost to society, including external benefits.
price effect
Price Effect: The socially optimal price (Popt) is lower than the market price (Pm).
quantity effect
Quantity Effect: The free market underproduces (Qm) compared to the socially optimal quantity (Qopt).
welfare loss
Welfare Loss: The triangle representing the deadweight loss due to underproduction caused by unaccounted external benefits.
Positive externalities of production occur when a firm's output generates external benefits to third parties that are not reflected in market prices.
In the free market equilibrium, firms produce at Qm where marginal private cost (MPC) equals marginal private benefit (MPB), resulting in price Pm.
However, the socially optimal output is Qopt, where marginal social cost (MSC) equals marginal social benefit (MSB).
Because MSC < MPC, the market underproduces (Qm < Qopt), and too few resources are allocated to the good.
The shaded triangle represents welfare loss — the benefit to society that is lost due to the lower level of production.
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