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Economics explained

Category:

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.

Subsidy

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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