Economics Perfect Competition Questions
Positive externalities occur when the production or consumption of a good or service benefits a third party who is not directly involved in the transaction. This leads to an underallocation of resources in a perfectly competitive market, as the market equilibrium quantity is lower than the socially optimal quantity. The positive externality creates a divergence between private and social benefits, resulting in a deadweight loss. To address this, government intervention such as subsidies or provision of public goods may be necessary to internalize the externality and achieve a more efficient outcome.
On the other hand, negative externalities arise when the production or consumption of a good or service imposes costs on third parties who are not involved in the transaction. In a perfectly competitive market, this leads to an overallocation of resources, as the market equilibrium quantity is higher than the socially optimal quantity. The negative externality creates a divergence between private and social costs, resulting in a deadweight loss. To mitigate this, government intervention such as taxes or regulations may be implemented to internalize the externality and achieve a more efficient outcome.