Page 207 - The Principle of Economics

yields greater spillovers than making potato chips, then the government should use the tax laws to encourage the production of computer chips relative to the production of potato chips. Government intervention in the economy that aims to promote technology-enhancing industries is called technology policy.
Other economists are skeptical about technology policy. Even if technology spillovers are common, the success of a technology policy requires that the government be able to measure the size of the spillovers from different mar- kets. This measurement problem is difficult at best. Moreover, without precise measurements, the political system may end up subsidizing those industries with the most political clout, rather than those that yield the largest positive externalities.
One type of technology policy that most economists endorse is patent pro- tection. The patent laws protect the rights of inventors by giving them exclusive use of their inventions for a period of time. When a firm makes a technological breakthrough, it can patent the idea and capture much of the economic benefit for itself. The patent is said to internalize the externality by giving the firm a property right over its invention. If other firms want to use the new technology, they would have to obtain permission from the inventing firm and pay it some royalty. Thus, the patent system gives firms a greater incentive to engage in re- search and other activities that advance technology.
EXTERNALITIES IN CONSUMPTION
The externalities we have discussed so far are associated with the production of goods. Some externalities, however, are associated with consumption. The con- sumption of alcohol, for instance, yields negative externalities if consumers are more likely to drive under its influence and risk the lives of others. Similarly, the consumption of education yields positive externalities because a more educated population leads to better government, which benefits everyone.
The analysis of consumption externalities is similar to the analysis of produc- tion externalities. As Figure 10-4 shows, the demand curve does not reflect the value to society of the good. Panel (a) shows the case of a negative consumption externality, such as that associated with alcohol. In this case, the social value is less than the private value, and the socially optimal quantity is smaller than the quan- tity determined by the private market. Panel (b) shows the case of a positive con- sumption externality, like that of education. In this case, the social value is greater than the private value, and the socially optimal quantity is greater than the quan- tity determined by the private market.
Once again, the government can correct the market failure by inducing market participants to internalize the externality. The appropriate response in the case of consumption externalities is similar to that in the case of production externalities. To move the market equilibrium closer to the social optimum, a negative external- ity requires a tax, and a positive externality requires a subsidy. In fact, that is ex- actly the policy the government follows: Alcoholic beverages are among the most highly taxed goods in our economy, and education is heavily subsidized through public schools and government scholarships.
As you may have noticed, these examples of externalities lead to some gen- eral lessons: Negative externalities in production or consumption lead markets to pro- duce a larger quantity than is socially desirable. Positive externalities in production
CHAPTER 10
EXTERNALITIES 211