Positive Externality and Government Intervention in Economics

Running head: ECONOMICS
Economics
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Introduction
The essay discusses various aspects related to different fields of economics. The
discussion includes both microeconomics and macroeconomics areas. Microeconomic is a
branch of economics that deals with individual decision making. Macroeconomics on the other
hand covers a broader area incorporating aggregating decision making process (Kreps, 2019). In
the absence of any external cost or benefit free market allocates resources efficiently and
maximizes welfare. However, with positive externality social marginal benefits deviates from
private marginal benefit causing market failure. Market produce inadequate output and hence,
government needs to intervene to increase output. An important phenomenon of labor market is
that with increase in age, workers tend to receive a higher wage because of higher experiences
and better skill. This often hurts young workers who despite having sufficient education are
forced to work in low paying jobs (Lagakos et al., 2018). Economic growth of a nation indicates
a sustain increase in aggregate output. Economic growth depends on different factors. These
factors explain difference in rate of economic growth among nations. Policies taken by
government affect both aggregate output and price level. A fall in money supply lowers
aggregate demand of the economy which in turn results in a lower GDP and lower price level.
Positive externality and government intervention
In a well-functioning market, involved costs and benefits of a transaction are
automatically absorbed by sellers and buyers in the market. There are however situations where
benefits or costs spill over to a third party rather than parties directly involved in transaction.
These type of spillover costs and benefits are termed as externalities. When additional costs
inflict on third party it is called negative externality (Cowell, 2018). In case where additional
benefits enjoyed by third party it is termed as positive externality. If externalities are present in

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any transaction, then free market fail to allocate resources efficiently and market failure occurs.
In order to correct the market failure government should intervene in the market with appropriate
policy tool.
With a positive externality, marginal social benefit is greater than private marginal
benefit. An example of positive externality is the completion of high school education by a
student. When a student completes high school education, he/she can reap the benefits from high
education in the form of better job prospects, high productivity resulting in a higher income for
the person. These are however not the only benefits that come with high degree of education.
The effect of education spills over to the society causing a positive externality. For example, an
educated society can take a better decision for electing political leaders. Society with more
educated people tends to have relatively lower crime rates (Baumol & Blinder, 2015). Whenever
these kind of externalities are present free market cannot perform efficiently resulting in a market
failure. The figure below explains resulted market failure from positive externality.

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Figure 1: Impact of a positive externality
In the above figure DD line shows private marginal benefit curve. The SS line represents
private marginal cost. When positive externality is present in the market, marginal social benefit
is greater than private marginal benefit. The social marginal benefit is shown by the line D1.
Now, if the market is left free, then equilibrium occurs where private marginal benefit intersects
the private marginal cost (Cowen & Tabarrok, 2015). The associated price and output are P1 and
Q1 respectively. Socially efficient point of equilibrium however is where social marginal benefit
intersects the marginal cost curve. The socially desirable outcome is at Q2 and that of socially
desirable price is P2.
As discussed above with a positive externality free market produces less than socially
optimal outcome. Government therefore should intervene in the market to encourage production
of such goods. The view of local politician that there is no need for government intervention
when positive externalities are present therefore is not right from economic point of view.
Association between pay and age
Payment to workers is the remuneration that they receive for supplying work hours.
There are different factors that determine wage of workers. Productivity of workers is the key
determinant of wage. It is generally observed that older workers tend to receive a higher wage
compared to younger workers. As worker gets older, they become more experienced. The
working experience increase productivity of workers (Thompson, 2016). Firms want to retain
experienced workers and therefore offer them a higher wage. Firms have to incur a higher cost
for training workers. Higher training cost adversely affects profitability of firms. At a younger
age, when workers first join the job market they lack proper training. Employers has to spend on