In this section we examine some examples. Market competition can provide an incentive for discovering new technology because a firm can earn higher profits by finding a way to produce products more cheaply or to create products with characteristics consumers want.
In certain cases, however, competition can discourage new technology, especially when other firms can quickly copy a new idea. Consider a pharmaceutical firm deciding to develop a new drug. Many inventors over the years have discovered that their inventions brought them less profit than they might have reasonably expected. A variety of studies by economists have found that the original inventor receives one-third to one-half of the total economic benefits from innovations, while other businesses and new product users receive the rest.
Will private firms in a market economy under invest in research and technology? If a firm builds a factory or buys a piece of equipment, the firm receives all the economic benefits that result from the investments. However, when a firm invests in new technology, the private benefits , or profits, that the firm receives are only a portion of the overall social benefits. The social benefits of an innovation take into account the value of all the positive externalities of the new idea or product, whether enjoyed by other companies or society as a whole, as well as the private benefits received by the firm that developed the new technology.
Positive externalities are beneficial spillovers to a third party, or parties. Economists and scientists working for Big Drug have compiled a list of potential research and development projects and estimated rates of return. The rate of return is the estimated payoff from the project. Figure 2 shows how the calculations work. After all, new innovations often spark other creative endeavors that society also values. Figure 2. Positive Externalities and Technology. However, other pharmaceutical firms and health care companies may learn new lessons about how to treat certain medical conditions and are then able to create their own competing products.
The social benefit of the drug takes into account the value of all the positive externalities of the drug. However, if Big Drug is receiving only 50 cents of each dollar of social benefits, the firm will not spend as much on creating new products. The amount it would be willing to spend would fall somewhere in between D Private and D Social. The investment in anything, whether it is the construction of a new power plant or research in a new cancer treatment, usually requires a certain upfront cost with an uncertain future benefit.
The investment in education, or human capital, is no different. Once the numbers are crunched, does this investment pay off for the student? Data in Table 2, from the U. In other words, your neighbor is bearing the explicit costs of dog ownership. Your neighbor also receives benefits from the dog, such as companionship and home security. But, what if the dog spends most of the night barking outside of your bedroom window, depriving you of valuable sleep?
In this case, you would be bearing some of the costs of your neighbor's dog ownership-and that would be a negative externality for you.
You could call your neighbor and try to reach an agreement. But, if that weren't successful, you might call the police, who may fine your neighbor. You could think of that as a type of corrective tax. On the other hand, let's assume your neighbor's dog doesn't keep you awake at night. Instead, Fido is perfectly quiet and only barks when suspicious looking strangers come near your homes.
Now the dog is providing you with the benefit of home security without you having to share in the cost of the dog-you receive a positive externality.
You might choose to "subsidize" Fido by taking care of the dog when your neighbor is away or by giving the dog a treat from time to time. To summarize, the costs and benefits of transactions for goods and services are often contained between the producers and consumers, but sometimes costs and benefits spill over to third parties. A negative externality exists when a cost spills over to a third party.
A positive externality exists when a benefit spills over to a third-party. Government can discourage negative externalities by taxing goods and services that generate spillover costs. Government can encourage positive externalities by subsidizing goods and services that generate spillover benefits.
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Permitted Use. The more education a person receives, the greater the social benefit since more educated people tend to be more enterprising, meaning they bring greater economic value to their community.
The social benefit SD of obtaining higher education is greater than that of the private benefit D. Because individuals do not factor in the social benefit, they are only interested in the private benefit and therefore they purchase a level of education which is not socially optimal. To increase the level of education, the government could offer an education subsidy which would lower the cost of education and encourage more people to obtain a higher level of education.
This would close the gap between P 1 and P 2 and increase the output of higher education. Therefore the individuals could pay the same price before accompanied by a subsidy and the overall level of education would increase and maximize the social benefit. Lyndon G. Fossil Fuels.
Nuclear Fuels. Acid Rain.
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