In a standard graphical model of a market with a positive consumption externality, the marginal social benefit (MSB) curve lies above the marginal private benefit (MPB) curve, and the supply curve represents the marginal social cost (MSC). The market's equilibrium results in a quantity that is less than the socially optimal quantity. To correct this market failure, what is the precise value of the per-unit subsidy that would align the private equilibrium with the social optimum?

Analyzing a Subsidy for Higher Education

A market for a good with a positive consumption externality is depicted on a standard graph. The curves are: S = Marginal Social Cost (MSC), D = Marginal Private Benefit (MPB), and MSB = Marginal Social Benefit, which lies above the D curve. The initial market equilibrium quantity is Qm (where D intersects S), and the socially optimal quantity is Qopt (where MSB intersects S). A corrective per-unit subsidy is implemented to move the market to Qopt. Match each economic concept with its correct graphical representation.

The table below shows the potential outcomes for two individuals, Player 1 and Player 2, based on their simultaneous choice between two actions: 'Action A' or 'Action B'. Player 1 is the 'row player' and their choices are listed down the side. Player 2 is the 'column player' and their choices are listed across the top. In each cell, the first number is the payoff for Player 1, and the second number is the payoff for Player 2.

If you know that Player 1 will choose 'Action B', what is Player 2's best choice to maximize their own payoff?

Consider a market for a good whose consumption creates a positive externality. The market is represented by a standard supply and demand graph where:

• The supply curve (S) represents the marginal social cost.
• The demand curve (D) represents the marginal private benefit.
• A third curve (MSB) represents the marginal social benefit and lies above the demand curve.
• The intersection of S and D occurs at quantity Q1.
• The intersection of S and MSB occurs at quantity Q2.
• At quantity Q2, the price on the S curve is P3, and the price on the D curve is P1.

If the government provides a per-unit subsidy to move the market from quantity Q1 to the socially optimal quantity Q2, which of the following represents the total cost of the subsidy to the government?

Graphical Effect of a Corrective Subsidy

A company producing a unique product faces a downward-sloping demand curve and has a series of isoprofit curves, each representing a different level of total profit. The company is considering a production plan where its chosen isoprofit curve intersects (crosses) the demand curve. Why is this point of intersection suboptimal for profit maximization?

In a market with a positive consumption externality, where the quantity produced is less than the socially optimal level, implementing a per-unit subsidy of any size will always lead to an increase in total social welfare compared to the initial market outcome.

Consider a market for a good where consumption provides benefits to individuals other than the direct consumer. The market is represented on a graph with Price on the vertical axis and Quantity on the horizontal axis.

• The upward-sloping supply curve represents the marginal social cost (MSC).
• The downward-sloping demand curve represents the marginal private benefit (MPB).
• A third curve, representing the marginal social benefit (MSB), lies above the demand curve.

The market initially operates at quantity Qm, where the MPB curve intersects the MSC curve. The socially efficient quantity is Qopt, where the MSB curve intersects the MSC curve. A corrective per-unit subsidy is introduced, successfully moving the market's output from Qm to Qopt.

Which of the following correctly identifies the area on the graph that represents the gain in total social welfare from this policy?

Consider a market for a good whose consumption generates benefits for third parties. The market is represented on a graph with Price on the vertical axis and Quantity on the horizontal axis.

• The upward-sloping supply curve (S) represents the marginal social cost.
• The downward-sloping demand curve (D) represents the marginal private benefit.
• A third curve, representing the marginal social benefit (MSB), lies above the demand curve.

The initial market equilibrium is at point E (quantity Qm, price Pm), where S and D intersect. The socially optimal outcome is at quantity Qopt, where S and MSB intersect. At this quantity, the price producers receive is Pp (point F on the S curve) and the price consumers pay is Pc (point G on the D curve).

A per-unit subsidy equal to the vertical distance between points F and G is implemented, moving the market from Qm to Qopt. Which of the following areas represents the change in consumer surplus due to the subsidy?