Positive Externalities Exercise 2 a. Which of the following situations exhibits a positive externality? Alan purchases a new watch as a gift for his father. Sean spends the afternoon cleaning his garage. Richard renovates a dilapidated historic home in the center of town. b. When there is a positive externality associated with the market: too little is produced. too much is produced. the socially optimal amount is produced. c. Governments may stimulate the economy to move toward the socially optimal output by: taxing the product. subsidizing the product. implementing a price ceiling.

Externalities are the positive or negative side effects to third party, without any monetary exchange for the same. Positive externalities are the positive side effects, without any monetary exchange.

Alan gifting watch to his father, Sean cleaning his garage : have no extra social positive side effect. These are not positive externalities. Richard renovating a dilapidated historic home in town center : as it benefits all the people around the locality who, not having a dilapidated building in their vicinity - in terms of cleanliness, less construction accident risk etc.

Markets work on basis of 'Marginal private benefit' , 'Marginal private cost' equalisation. Positive externalities have extra social benefit. So, their total benefit being more than their private benefit - make markets underproduce than their socially optimal quantity

Government should subsidise the product. As this will internalise the extra social benefit due to positive externalities. And, it will also solve the problem of under production than socially optimal quantity.