Positive Production Externalities

• • Producers maximise private benefit by producing an output of Q1 trees, which is directly below point X where MPC = MPB.
• • However, Q1 is less than the socially optimal level of output of Q2, which is directly below point Y where MSC = MSB.
• • Essentially, when positive production externalities are generated, the market fails as the good is under-produced, shown by the difference between Q1 and Q2, an example of partial market failure.
• • The shaded area represents the DWL, which exists at the privately optimal level of output of Q1, all the forward to the socially optimal level of Q2.
• • When production takes place at the socially optimal level of output of Q2 (where MSC = MSB) at point Y, the DWL is eliminated which is also known as a welfare gain. There is a net gain in social welfare if the trees between Q1 and Q2 are planted, as the MSB is greater than the MSC for each unit up to the socially optimal level of output where MSC = MSB.