IB Economics SL & HLTopic 2.8 — Externalities & Common Pool ResourcesPaper 1 & 2Diagram skill~11 min read
Positive Externalities and Merit Goods
Spillovers are not always harmful. When you get vaccinated you protect yourself, but you also protect everyone you would have infected. Nobody pays you for that. And because nobody pays you for it, the market quietly makes less of it than society would want.
📚 What you need to know
A positive externality is a benefit received by a third party who was not part of the transaction.
Of production: the benefit comes from making the good, so the supply side splits and MSC sits below MPC.
Of consumption: the benefit comes from using it, so the demand side splits and MSB sits above MPB.
Either way the market under-provides: Qe is smaller than Qopt.
The triangle here is a potential welfare gain — benefit society could have had and did not.
Merit goods are goods with external benefits in consumption that people under-consume.
More factors of production should be going into these goods.
Positive externalities of production
A beekeeper sells honey. The bees also pollinate every orchard for miles around, and those farmers get a better harvest without paying a cent. The beekeeper’s private cost of producing honey is therefore higher than the true cost to society, because society is getting something extra thrown in.
That means MSC lies below MPC. The gap between them is the external benefit per unit.
The triangle still points at Qopt. The only difference is that Qopt now sits to the right of the free market outcome.
Positive externalities of consumption
This is the version you will meet most often, because it covers merit goods. When you get a vaccination or finish a degree, the benefit does not stop with you. Other people do not catch the disease. Employers get a better worker. The government collects more tax and pays out less in benefits.
Buyers only weigh up their own benefit, so MPB is lower than the true MSB. The market settles at a quantity below what society would choose.
Merit goods live on this diagram. Vaccinations, schooling, public transport, home insulation — all of them help people who never paid.
A quick sanity check. Positive externality diagrams always end with Qopt to the right of Qe. If your optimum came out on the left, you have drawn a negative externality by mistake.
Merit goods
A merit good is beneficial and under-consumed. Two separate things hold consumption down, and strong answers mention both.
The external benefit is ignored. You do not get paid for the good your education does to everyone else, so you do not factor it in.
People undervalue their own private benefit. Health checks and pensions pay off years later, and we are all bad at valuing that.
On top of that, merit goods are often expensive, so people on low incomes are priced out even when they do see the value. That is why governments so often provide them directly rather than just subsidising them.
Merit goods and public goods are not the same thing. Firms will supply merit goods, just not enough of them. Firms will supply almost no public goods at all. Mixing these up is a classic lost mark.
Feature
Merit good
Public good
Will private firms supply it?
Yes, but too little
Almost none at all
Can people be excluded?
Yes, by price
No
Why does the market fail?
External benefits are ignored
Non-excludable and non-rival, so free riding
Common response
Subsidy, education, part-provision
Full government provision
Example
Vaccination, schooling
Street lighting, national defence
Worked examples
WORKED EXAMPLE
Potential welfare gain from vaccination
200,000 vaccinations are given. The socially optimum number is 260,000. At the free market quantity, MSB is $34 and MPB is $25. Calculate the welfare loss. [2]
Step 1: Under-consumption260,000 − 200,000 = 60,000 vaccinationsStep 2: Gap at Qe34 − 25 = $9Step 3: Area(60,000 × 9) ÷ 2 = 270,000Welfare loss = $270,000it is a loss now, but a potential gain if the government closes the gap
WORKED EXAMPLE
Sizing the subsidy
Using the same market, each vaccination creates an external benefit of $9. Calculate the total external benefit at the optimum, and state the subsidy needed per unit. [3]
Step 1: Total external benefit at Qopt9 × 260,000 = 2,340,000Total external benefit = $2.34 millionStep 2: The subsidy
To reach Qopt the subsidy per unit should equal the external benefit.
Subsidy = $9 per vaccinationtotal cost to the government = 9 x 260,000 = $2.34 million
WORKED EXAMPLE
Production or consumption?
For each case, state the type of externality and which curve splits. [4]
a) A firm trains apprentices who later work elsewhere
Positive externality of production. MSC below MPC.
b) A household installs solar panels
Positive externality of consumption. MSB above MPB.
c) A quarry creates dust across a village
Negative externality of production. MSC above MPC.
d) Loud music from a night club
Negative externality of consumption. MSB below MPB.
the question to ask is always: did the spillover come from making it or from using it?
💡 Exam tip
Call the triangle a welfare loss or a potential welfare gain. Both are accepted, and saying either shows you know what it represents.
Draw the third curve parallel to the one it splits from unless a question says otherwise. It keeps the external effect constant per unit.
Finish with the resource sentence: more factors of production should be allocated here.
For merit goods, give both reasons for under-consumption — ignored external benefits and undervalued private benefits.
Good examples: vaccination, education, public transport, home insulation, apprenticeship training.
Evaluation: benefits like “a better educated population” are almost impossible to price, so any subsidy is an estimate.
⚠ Common mix-up
Drawing MSB below MPB for a positive externality. Extra benefit means the social curve is the higher one.
Putting Qopt to the left. With positive externalities society wants more, so Qopt is on the right.
Treating merit goods and public goods as the same. Merit goods are supplied by firms, just not enough.
Saying “there is no market failure because everyone gains”. There is. Society is not getting all the benefit it could.
Forgetting the price direction. Positive consumption externality means the optimum price is higher, not lower.
Shading the triangle from the axis. It lives between the two curves, between Qe and Qopt.
Up next: Common Pool Resources and the Tragedy of the Commons — what happens when a resource belongs to everybody and therefore to nobody.
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