Evaluation of Methods to

Correct Positive Externalities

Unit 5 - Lesson 10
Learning outcomes:
Discuss the strengths and limitations of legislation, nudges, subsidies,
educational awareness and direct government provision with respect to: (AO3)

● Difficulties in measurement of the externalities.

● Degree of effectiveness
● Impact on the stakeholders
 Direct Government Provision and Subsidies
Both Direct Government Provision
and Subsidies are popular and
effective ways to address the
underallocation of resources
associated with Positive Externalities.

Direct Government Provision increases

the quantity from (Qfm) to (Qso).

Direct Government Provision aides in

decreasing the price from (Pfm) to (Pc)
 Direct Government Provision and Subsidies

Subsidies have the same impact as

Direct Government Provision by
incentivizing the producer to increase
the quantity produced from (Qfm) to
(Qso) resulting in a decrease in price
the consumer pays from (Pfm) to (Pc).

Subsidies also increase the price the

producer receives from (Pfm) to (Pso)
resulting in an increase in revenue for
the producer of the goods.
 Direct Government Provision and Subsidies
Limitations of Direct Government Provision and Subsidies
Direct government provision and subsidies require governments to use tax
revenue collected from society. Since it is not possible to fund all programs that
are deemed desirable to society, the government must make a choice on what
programs to fund, which ones not to fund and how much to fund. These choices
result in opportunity costs.
Governments should fund programs based on an economic criteria related to
the social benefits gained to the social cost to provide them. By basing it on
an economic criteria the goal is to fund the program with the most amount of
social benefit relative to the cost.
However, it is very difficult to measure the positive benefits of each program
and therefore it is hard to choose which program to fund and how much to fund
the program.
 Direct Government Provision and Subsidies

Limitations of Direct Government Provision and Subsidies

● Political pressure on leaders is a challenge as some politicians make the
choice of what program to fund and how much to fund it based on politics
rather than economic criteria.

Policies such as Direct Government Provision and Subsidies are

beneficial in lowering the price the consumer pays and in the case of
subsidies increasing the price the producer receives. This decrease
in price paid for by the consumer incentivizes consumers to
increase the quantity demanded in the market moving closer to the
socially optimal quantity.
 Nudges

Nudges are designed to try and influence

individuals to make choices that are
deemed socially desirable.
○ Examples include the creation of
bike lanes and graphic photos on
cigarette packaging.
If nudges work influencing consumers to
make socially desirable choices it will
result in a increase in MPB moving it closer
to MSB resulting in a increase in quantity
from Qfm to Qso.
Advantages and Limitations of Nudges
There may be difficulties in designing Nudges to effectively influence
consumers of demerit goods to make socially desirable choices.
Behavioural Economics and Nudges are relatively new so knowing how
consumers will react to Nudges and Choice Architecture is relatively limited.
Also, Nudges may not have the same effect across income and cultural
groups thus reducing the effect.
Overall, the use of subsidies, direct government provision and nudges will
not realistically increase the quantity in the market to the socially optimal
quantity because of the limitations mentioned before. It is effective in
reducing the underallocation of resources in the market and helps reduce the
underprovision of the good.
 Legislation and Educational Awareness
Legislation and Educational Awareness
● Face the same challenges as subsidies and direct government provision in
that it is very difficult to measure the external benefits society gains from the
production or consumption of a good.
● Legislation and Educational Awareness are effective at increasing the MPB
(shift right) closer to the socially optimal quantity, but not completely
eliminate the underallocation of resources.
● Legislation and Educational Awareness are effective in some cases such as
mandatory schooling age and not as effective in others.
● Another drawback is the increase in MPB = D caused by these type of
policies result in an increase in price thus making it unaffordable for some
households.
 Legislation and Educational Awareness

Legislation and Educational Awareness

Legislation and Educational Awareness are effective tools in helping to
increase the demand (MPB = D) for goods and services that have positive
external benefits for society, however they increase the price of the good or
services thus making it unaffordable to lower income households.
Therefore, to combat this increase in price and further influence the quantity
in the market, governments should complement these policies with
subsidies or direct government provision.

In short a combination of policies is the best way to address the

underallocation and under-provision of goods deemed to have positive
external benefits for society.