If the government subsidizes an activity it believes is generates a positive externality and it really only produces an inframarginal positive externality then the subsidization will result in an overproduction of the activity in question.

Question

Quizplus · Accepted Answer

If the positive externality is only inframarginal, then the costs of the additional units produced will exceed the benefits. By subsidizing the activity, the government lowers the cost of production and encourages more output, leading to an overproduction of the activity and a misallocation of resources.

If the Government Subsidizes an Activity It Believes Is Generates