AP_Krugman_Textbook

module 75 Externalities and Public Policy 737

Section 14 Market Failure and the Role of Government
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-
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
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
benefits are the private benefit that accrues to you from not getting the flu yourself,
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 EMKT, with QMKTflu shots being bought and sold at the market price of PMKT.

Your flu shot provides positive exter-

nalities to those whom you would

otherwise make sick.

iStockphoto

S

D

MSB of

flu shots

O

Marginal

external

benefit

(a) Positive Externality

Price,

marginal

social

benefit

of flu shot

Optimal

Pigouvian

subsidy

Quantity

of flu shots

Price of

flu shot

QOPT

POPT

PMSB

PMKT

QMKT

S

D

O

Quantity

of flu shots

QMKT QOPT

(b) Optimal Pigouvian Subsidy

Price to

consumers

after

subsidy

Price to

producers

after

subsidy

EMKT EMKT

figure 75.3 Positive Externalities and Consumption

Consumption of flu shots generates external benefits, so the

marginal social benefit curve, MSB,of flu shots, corresponds to

the demand curve, D,shifted upward by the marginal external

benefit. Panel (a) shows that without government action, the mar-

ket produces QMKT. It is lower than the socially optimal quantity

of consumption, QOPT,the quantity at which MSBcrosses the

supply curve, S.At QMKT,the marginal social benefit of another

flu shot, PMSB,is greater than the marginal private benefit to

consumers of another flu shot, PMKT.Panel (b) shows how an op-

timal Pigouvian subsidy to consumers, equal to the marginal ex-

ternal benefit, moves consumption to QOPTby lowering the price

paid by consumers.