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economist to suggest a new T-shirt slogan, one particularly suited for the winter
months: “Kiss Me, I’m Vaccinated!” When you get vaccinated against the flu,
it’s likely that you’re conferring a substantial benefit on those around you—a
benefit for others that you are not compensated for. In other words, getting
a flu shot generates a positive externality.
The government can directly control the external costs of pollution
because it can measure emissions. In contrast, it can’t observe the re-
duction in flu cases caused by you getting a flu shot, so it can’t directly
control the external benefits—say, by rewarding you based on how many
fewer people caught the flu because of your actions. So if the govern- Section 14 Market Failure and the Role of Government
ment wants to influence the level of external benefits from flu vaccina-
tions, it must target the original activity—getting a flu shot.
From the point of view of society as a whole, a flu shot carries both iStockphoto
costs (the price you pay for the shot, which compensates the vaccine maker
and your health care provider for the inputs and factors of production
necessary to grow the vaccine and deliver it to your bloodstream) and benefits. Those Your flu shot provides positive exter-
nalities to those whom you would
benefits are the private benefit that accrues to you from not getting the flu yourself, otherwise make sick.
but they also include the external benefits that accrue to others from a lower likelihood
of catching the flu. However, you have no incentive to take into account the beneficial
side effects that are generated by your actions. As a result, in the absence of government
intervention, too few people will choose to be vaccinated.
Panel (a) of Figure 75.3 illustrates this point. The market demand curve for flu
shots is represented by the curve D; the market, or industry, supply curve is given by
the curve S. In the absence of government intervention, market equilibrium will be at
point E MKT , with Q M KT flu shots being bought and sold at the market price of P MKT .

figure 75.3 Positive Externalities and Consumption

(a) Positive Externality (b) Optimal Pigouvian Subsidy
Price, Price of
marginal flu shot
social
benefit Marginal
of flu shot external
benefit S Price to S
producers
P MSB after
O subsidy O
P OPT
Optimal
P MKT E MKT Pigouvian E MKT
MSB of subsidy
flu shots
Price to
consumers
D after D
subsidy
Q MKT Q OPT Quantity Q MKT Q OPT Quantity
of flu shots of flu shots

Consumption of flu shots generates external benefits, so the supply curve, S. At Q MKT , the marginal social benefit of another
marginal social benefit curve, MSB, of flu shots, corresponds to flu shot, P MSB , is greater than the marginal private benefit to
the demand curve, D, shifted upward by the marginal external consumers of another flu shot, P MKT . Panel (b) shows how an op-
benefit. Panel (a) shows that without government action, the mar- timal Pigouvian subsidy to consumers, equal to the marginal ex-
ket produces Q MKT . It is lower than the socially optimal quantity ternal benefit, moves consumption to Q OPT by lowering the price
of consumption, Q OPT , the quantity at which MSB crosses the paid by consumers.

module 75 Exter nalities and Public Policy 737