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Economics explained


Market failure

Government intervention and positive production externalities

Government intervention and positive production externalities

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The figure below shows how a subsidy to the firm generating these benefits would correct market failure.

The market equilibrium

The market equilibrium is at P1 Q1; the market under allocates resources at this point.


It is implied that the government should provide a subsidy to the firm equal to the external benefit.

As a result, there will be an increase in the quantity produced to Q2 and a lower price at P2.

Allocative efficiency is now being achieved.

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