Quiz 4: Education

Business

The externality is the cost or benefit of an economic activity that spill over onto the society. A positive externality provides a benefit to the society and is called spillover benefit. The classic example of spillover benefit is education. The spillover benefit often gives rise to inefficiency and distorts the allocation of resources. In education, it will not be fair if the student have to pay all the cost of education because the spillover benefit of education benefits the whole society. Therefore, the individual value education relatively lower than what is socially desirable. Then if the education is traded in private market the market equilibrium would be much lower than what is social optimum. Hence, we say that the spillover benefit distorts the allocation of resources in education.

The externality is the cost or benefit of an economic activity that spill over onto the society. A positive externality provides a benefit to the society and is called spillover benefit. The classic example of spillover benefit is education. A negative externality provides a cost to the society and is called spillover cost. The classic example of spillover cost is pollution. The presence of negative externality distorts the resource allocation in the sense that they generate an output level which is either greater than or less than socially optimal level. That is the market either under produce or over produce the output. Let us consider the resource allocation of a hypothetical industry: paper industry. The demand and the supply curve of the industry are given in figure 1 below. Initially, we assume no pollution and the equilibrium price and quantity with no spill over cost is P and Q. This is also the socially desirable output level. img Figure 1 Now suppose that the paper industry thought it would be too expensive to prevent pollution and stars dumping its waste in adjacent river. This causes the water pollution but saves the cost of maintaining anti polluting measure to the firm. Hence, the cost of controlling pollution decreases and this reduces the cost of production of the paper firm. This increases the paper supply and the market supply curve for paper industry shifts rightward to S', as shown in the left panel of the above figure. (1) Given the demand, a rise in supply decreases the demand for that product. The equilibrium price decreases to P' in the figure above. Hence, pollution results in a lower price of the good when its production creates a spill over. (2) This increases the equilibrium output to Q'. However, this output is not the social optimal as the firm does not take into account the social cost or the spill over cost of the pollution and go on producing more than the social desirable output. Hence, in this case pollution causes overproduction of output and thus over allocation of resources towards producing the good.

The externality is the cost or benefit of an economic activity that spill over onto the society. A positive externality provides a benefit to the society and is called spillover benefit. The classic example of spillover benefit is education. A negative externality provides a cost to the society and is called spillover cost. The classic example of spillover cost is pollution. The presence of positive externality distorts the resource allocation in the sense that they generate an output level which is less than socially optimal level. That is the market under produce the output. Let us consider a hypothetical society where education causes under production of resources from the spill over benefit of education. The figure below shows the private and social demand for education and supply of education in the society. img Figure Here in figure D P represents the private demand for education, this is determined by the perception of the benefit the students and their family will get from the education. Given the supply of education the equilibrium quantity is 5 million. That is 5 million students will enroll. The private demand curve does not take into account the social benefit obtained from education. If we incorporate the social benefit into the demand curve, the social demand will be greater and will be given by the curve D S. (1) Given the supply curve the social demand for education gives a higher equilibrium quantity of 6 million. That is if we incorporate the social benefit associated with the education 6 million people will enroll. (2) This will also increase the equilibrium price of education. That is now the students have to pay higher fees to obtain the education.

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