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Positive Production externalities

These are positive externalities created due to production of certain goods and services. Examples include, when firms train their employees which result in better manpower or invest in research and development and succeed in developing new technologies which benefits the society.

Due to the fact that positive externality is produced, the MSC lies below the MPC. The diagram below illustrates positive production externalities. As we can see that the social optimal level of production of these goods should be Q* , however there is underallocation of resources and thus there is output is at Q1.

market-failure3

Corrective positive production externalities

Subsidies can be provided to firms which produce these goods. The effect will be the lowering of MPC and thus the MPC will more downward to MSC. This will increase the output to a level Q2 near to the socially optimal level Q*. The price will also fall from P1 to P2.

market-failure4

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