Question

Do market demand curves reflect positive externalities? Why or why not?

Short answer

In conclusion, market demand curves do not reflect positive externalities because they only account for the private benefits experienced by consumers, not the additional benefits experienced by third parties. This discrepancy between private and social benefits means that the market equilibrium does not represent the socially optimal level of output and leads to underproduction and underconsumption of the good or service with positive externalities.

Step-by-step solution

Define Market Demand Curve

A market demand curve is a graphical representation of the quantity of a product that consumers are willing and able to buy at various prices, holding all other factors constant. It usually slopes downward from left to right, indicating that as the price of a product decreases, the quantity demanded by consumers increases.

Understand Positive Externalities

Positive externalities are benefits that accrue to third parties not directly involved in the production or consumption of a good or service. In other words, they are the positive spillover effects of an economic activity. When there are positive externalities, the social benefits (i.e., the total benefits to society) of a good or service are greater than the private benefits.

Analyze the Market Demand Curve under Positive Externalities

In the presence of positive externalities, the market demand curve does not fully account for all the social benefits of a good or service. This is because it only reflects the private benefits that accrue directly to consumers from consuming a good or service. It does not take into account the additional benefits that accrue to third parties.

Illustrate the Market Equilibrium with Positive Externalities

When there are positive externalities in a market, the market equilibrium (the point at which the market demand curve intersects the market supply curve) does not represent the socially optimal level of output. At the market equilibrium, the social marginal benefit (SMB) of the good or service is greater than the private marginal benefit (PMB). This means that society would be better off if more of the good or service were produced and consumed. In other words, there is a deadweight loss associated with positive externalities due to the underproduction and underconsumption of the good or service.

Conclusion

In conclusion, market demand curves do not reflect positive externalities because they only account for the private benefits experienced by consumers, not the additional benefits experienced by third parties. This discrepancy between private and social benefits means that the market equilibrium does not represent the socially optimal level of output and leads to underproduction and underconsumption of the good or service with positive externalities.