{"id":6546,"date":"2018-02-05T15:37:42","date_gmt":"2018-02-05T15:37:42","guid":{"rendered":"https:\/\/courses.lumenlearning.com\/wm-microeconomics\/chapter\/reading-positive-externalities-and-technology\/"},"modified":"2024-04-25T23:02:47","modified_gmt":"2024-04-25T23:02:47","slug":"positive-externalities-and-technology","status":"publish","type":"chapter","link":"https:\/\/courses.lumenlearning.com\/wm-microeconomics\/chapter\/positive-externalities-and-technology\/","title":{"raw":"Positive Externalities and Technology","rendered":"Positive Externalities and Technology"},"content":{"raw":"<div class=\"textbox learning-objectives\">\r\n<h3>Learning Objectives<\/h3>\r\n<ul>\r\n \t<li>Identify and explain positive externalities, including new technology<\/li>\r\n \t<li>Show how differences between private benefits and social benefits cause market failure<\/li>\r\n<\/ul>\r\n<\/div>\r\nIndividual demand reflects the marginal benefits a consumer receives from some product. When we sum all individual demands, we get the market demand. Market demand captures the <strong>marginal private benefits<\/strong>\u00a0(MPB) of the product, since it measures the benefits received by the consumers who purchase the product.\u00a0Figure 1 shows the market demand curve as MPB.\r\n\r\n[caption id=\"attachment_9166\" align=\"aligncenter\" width=\"551\"]<img class=\"wp-image-9166\" src=\"https:\/\/s3-us-west-2.amazonaws.com\/courses-images\/wp-content\/uploads\/sites\/2042\/2018\/02\/05200545\/MPB.jpg\" alt=\"Two demand curves. The first is the private demand, or MPB, and the second shows that MPB plus external benefits equals the MSB.\" width=\"551\" height=\"413\" \/> <strong>Figure 1.<\/strong> Marginal private benefits plus external benefits equal marginal social benefits.[\/caption]\r\n\r\nSome products provide both private and external benefits. <strong>External benefits<\/strong> are benefits received by someone who didn\u2019t purchase the product, but received some benefits as a spillover or side effect of the consumer\u2019s purchasing the product. When external benefits exist, we describe the situation as a <strong>positive externality<\/strong>, where the marginal benefit to society is greater than the marginal benefits to the consumers who purchased the product. The <strong>marginal social benefits (MSB)<\/strong> are the marginal private benefits plus the external benefits. Figure 1 shows the social demand curve as MSB.\u00a0Failure to consider those external benefits results in a market failure. In this section we examine some examples.\r\n<h2>Positive Externalities and Private Benefits<\/h2>\r\nMarket 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. As Gregory Lee, CEO of Samsung said, \"Relentless pursuit of new innovation is the key principle of our business and enables consumers to discover a world of possibilities with technology.\" An innovative firm knows that it will usually have a temporary edge over its competitors and thus an ability to earn above-normal profits before competitors can catch up.\r\n\r\nIn 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. On average, it can cost $800 million and take more than a decade to discover a new drug, perform the necessary safety tests, and bring the drug to market. If the research and development (R&amp;D) effort fails\u2014and every R&amp;D project has some chance of failure\u2014then the firm will suffer losses and could even be driven out of business. If the project succeeds, then the firm's competitors may figure out ways of adapting and copying the underlying idea, but without having to pay the costs themselves. As a result, the innovative company will bear the much higher costs of the R&amp;D and will enjoy at best only a small, temporary advantage over the competition.\r\n\r\nMany inventors over the years have discovered that their inventions brought them less profit than they might have reasonably expected.\r\n<ul>\r\n \t<li>Eli Whitney (1765\u20131825) invented the cotton gin, but then southern cotton planters built their own seed-separating devices with a few minor changes in Whitney's design. When Whitney sued, he found that the courts in southern states would not uphold his patent rights.<\/li>\r\n \t<li>Thomas Edison (1847\u20131931) still holds the record for most patents granted to an individual. His first invention was an automatic vote counter, and despite the social benefits, he could not find a government that wanted to buy it.<\/li>\r\n \t<li>Gordon Gould (1920\u20132005) came up with the idea behind the laser in 1957. He put off applying for a patent and, by the time he did apply, other scientists had laser inventions of their own. A lengthy legal battle resulted, in which Gould spent $100,000 on lawyers, before he eventually received a patent for the laser in 1977. Compared to the enormous social benefits of the laser, Gould received relatively little financial reward.<\/li>\r\n<\/ul>\r\nA 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.\r\n<h2>Positive Externalities of New Technology<\/h2>\r\nWill 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 <strong>private benefits<\/strong>, or profits, that the firm receives are only a portion of the overall social benefits. The <strong>social benefits<\/strong> 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. <strong>Positive externalities<\/strong> are beneficial spillovers to a third party, or parties.\r\n\r\nConsider the example of the Big Drug Company, which is planning its R&amp;D budget for the next year. Economists and scientists working for Big Drug have compiled a list of potential research and development projects and estimated rates of return. (The <strong>rate of return<\/strong> is the estimated payoff from the project.) Figure 2 shows how the calculations work. The downward-sloping D<sub>Private<\/sub> curve represents the firm\u2019s demand for financial capital and reflects the company\u2019s willingness to borrow to finance research and development projects at various interest rates. Suppose that this firm\u2019s investment in research and development creates a spillover benefit to other firms and households. After all, new innovations often spark other creative endeavors that society also values. If we add the spillover benefits society enjoys to the firm\u2019s private demand for financial capital, we can draw D<sub>Social<\/sub> that lies above D<sub>Private<\/sub>.\r\n\r\n[caption id=\"\" align=\"aligncenter\" width=\"457\"]<img class=\"\" src=\"https:\/\/s3-us-west-2.amazonaws.com\/courses-images\/wp-content\/uploads\/sites\/2042\/2018\/02\/05153738\/CNX_Econ_C13_002.jpg\" alt=\"The graph shows the different demand curves based on whether or not a firm receives social benefits in addition to private benefits.\" width=\"457\" height=\"295\" \/> <strong>Figure 2.<\/strong> <strong>Positive Externalities and Technology.<\/strong> Big Drug faces a cost of borrowing of 8%. If the firm receives only the private benefits of investing in R&amp;D, then its demand curve for financial capital is shown by D<sub>Private<\/sub>, and the equilibrium will occur at $30 million. Because there are spillover benefits, society would find it optimal to have $52 million of investment. If the firm could keep the social benefits of its investment for itself, its demand curve for financial capital would be D<sub>Social<\/sub> and it would be willing to borrow $52 million.[\/caption]\r\n\r\nIf there was a way for the firm to fully monopolize those social benefits by somehow making them unavailable to the rest of us, the firm's private demand curve would be the same as society's demand curve. According to Figure 2 and Table 1, if the going rate of interest on borrowing is 8%, and the company can receive the private benefits of innovation only, then the company would finance $30 million. Society, at the same rate of 8%, would find it optimal to have $52 million of borrowing. Unless there is a way for the company to fully enjoy the total benefits, then it will borrow less than the socially optimal level of $52 million.\r\n<table id=\"ch13mod01_tab01\" summary=\"This table has three columns and six rows. The first row is a header row, and it labels the columns, 'Rates of Return', 'D_{Private} (in millions)', and 'D_{Social} (in millions)'. Under the column 'Rate of Return' are the following values: 2%, 4%, 6%, 8%, and 10%. Under the 'D_{Private} (in millions)' column are the following values: $72, $52, $38, $30, and $26. Under the 'D_{Social} (in millions)' column are the following values: $84, $72, $62, $52, and $44.\">\r\n<thead>\r\n<tr>\r\n<th colspan=\"3\">Table 1. Return and Demand for Capital<\/th>\r\n<\/tr>\r\n<\/thead>\r\n<tbody>\r\n<tr>\r\n<th>Rate of Return<\/th>\r\n<th>D<sub>Private<\/sub> (in millions)<\/th>\r\n<th>D<sub>Social<\/sub> (in millions)<\/th>\r\n<\/tr>\r\n<tr>\r\n<td>2%<\/td>\r\n<td>$72<\/td>\r\n<td>$84<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>4%<\/td>\r\n<td>$52<\/td>\r\n<td>$72<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>6%<\/td>\r\n<td>$38<\/td>\r\n<td>$62<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>8%<\/td>\r\n<td>$30<\/td>\r\n<td>$52<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>10%<\/td>\r\n<td>$26<\/td>\r\n<td>$44<\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\nBig Drug's original demand for financial capital (D<sub>Private<\/sub>) is based on the profits received by the firm. 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. If Big Drug were able to gain this social return instead of other companies, its demand for financial capital would shift to the demand curve D<sub>Social<\/sub>, and it would be willing to borrow and invest $52 million. 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<sub>Private<\/sub> and D<sub>Social<\/sub>.\r\n<div class=\"textbox tryit\">\r\n<h3>Try It<\/h3>\r\nhttps:\/\/assess.lumenlearning.com\/practice\/9a05c049-c618-4b42-a658-91a95d17435e\r\n\r\nhttps:\/\/assess.lumenlearning.com\/practice\/ddfee036-7c8c-4282-add9-39a83476a64e\r\n\r\n<\/div>\r\n<h2>Why Invest in Human Capital?<\/h2>\r\nThe 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. Over the span of many years, a student and her family invest significant amounts of time and money into that student's education. The idea is that higher levels of educational attainment will eventually serve to increase the student's future productivity and subsequent ability to earn. Once the numbers are crunched, does this investment pay off for the student?\r\n<p id=\"fs-idm175347168\">Almost universally, economists have found that the answer to this question is a clear \"Yes.\" For example, several studies of the return to education in the United States estimate that the rate of return to a college education is approximately 10-15%. Data in Table 2, from the U.S. Bureau of Labor Statistics\u2019 <em>Usual Weekly Earnings of Wage and Salary Workers, Third Quarter 2016,<\/em> demonstrate that median weekly earnings are higher for workers who have completed more education. While these rates of return will beat equivalent investments in Treasury bonds or savings accounts, the estimated returns to education go primarily to the individual worker, so these returns are private rates of return to education.<\/p>\r\n\r\n<table id=\"ch13mod01_tab02\" summary=\"This table has four columns and one row. The first row is a header row and it labels the last three columns, 'Less than a High School Degree,' 'High School Degree, No College,' and 'Bachelor's Degree.' Under the 'Less than a High School Degree' column is the value: $488. Under the 'High School Degree, No College' column is the value: $668. Under the 'Bachelor's Degree' column is the value: ,101.\"><caption>Table 2. Usual Weekly Earnings of Wage and Salary Workers, Fourth Quarter 2016\u00a0(Source: http:\/\/www.bls.gov\/news.release\/pdf\/wkyeng.pdf)<\/caption>\r\n<thead>\r\n<tr>\r\n<th><\/th>\r\n<th>Less than a High School Degree<\/th>\r\n<th>High School Degree, No College<\/th>\r\n<th>Bachelor\u2019s Degree<\/th>\r\n<\/tr>\r\n<\/thead>\r\n<tbody>\r\n<tr>\r\n<td>Median Weekly Earnings (full-time workers over the age of 25)<\/td>\r\n<td>$519<\/td>\r\n<td>$698<\/td>\r\n<td>$1,270<\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\nWhat does society gain from investing in the education of another student? After all, if the government is spending taxpayer dollars to subsidize public education, society should expect some kind of return on that spending. Economists like\u00a0<span class=\"no-emphasis\">George Psacharopoulos<\/span>\u00a0have found that, across a variety of nations, the\u00a0social rate of return\u00a0on schooling is also positive. After all, positive externalities exist from investment in education. While not always easy to measure, according to\u00a0<span class=\"no-emphasis\">Walter McMahon<\/span>, the positive externalities to education typically include better health outcomes for the population, lower levels of crime, a cleaner environment and a more stable, democratic government. For these reasons, many nations have chosen to use taxpayer dollars to subsidize primary, secondary, and higher education. Education clearly benefits the person who receives it, but a society where most people have a good level of education provides positive externalities for all.\r\n<h2>Other Examples of Positive Externalities<\/h2>\r\nAlthough technology may be the most prominent example of a positive externality, it is not the only one. For example, being vaccinated against disease is not only a protection for the individual, but it has the positive spillover of protecting others who may become infected. When a number of homes in a neighborhood are modernized, updated, and restored, not only does it increase the value of those homes, but the value of other properties in the neighborhood may increase as well.\r\n<p id=\"fs-idm108426544\">Figure 3 shows the market for flu shots. The market demand curve D<sub>Market<\/sub> for flu shots reflects only the marginal private benefits (MPB) that the vaccinated individuals receive from the shots. Assuming that there are no spillover costs in the production of flu shots, the market supply curve is given by the marginal private cost (MPC) of producing the vaccinations.<\/p>\r\n<p id=\"fs-idm109011616\">The equilibrium quantity of flu shots produced in the market, where MPB is equal to MPC, is Q<sub>Market<\/sub> and the price of flu shots is P<sub>Market<\/sub>. However, spillover benefits exist in this market because others, those who chose not to purchase a flu shot, receive a positive externality in a reduced chance of contracting the flu. When we add the spillover benefits to the marginal private benefit of flu shots, the marginal social benefit (MSB) of flu shots is given by D<sub>Social<\/sub>. Because the MSB is greater than MPB, we see that the socially optimal level of flu shots is greater than the market quantity (Q<sub>Social<\/sub> exceeds Q<sub>Market<\/sub>) and the corresponding price of flu shots, if the market were to produce Q<sub>Social<\/sub>, would be at P<sub>Social<\/sub>. Unfortunately, the marketplace does not recognize the positive externality and flu shots will go under produced and under consumed.<\/p>\r\n<p id=\"fs-idm165710736\">How can government try to move the market level of output closer to the socially desirable level of output? One policy would be to provide a subsidy, like a voucher, to any citizen who wishes to get vaccinated. This voucher would act as \"income\" that one could use purchase only a flu shot and, if the voucher were exactly equal to the per-unit spillover benefits, would increase market equilibrium to a quantity of Q<sub>Social<\/sub> and a price of P<sub>Social<\/sub> where MSB equals MSC. Suppliers of the flu shots would receive payment of P<sub>Social<\/sub> per vaccination, while consumers of flu shots would redeem the voucher and only pay a price of P<sub>Subsidy<\/sub>. When the government uses a subsidy in this way, it produces the socially optimal quantity of vaccinations.<\/p>\r\n\r\n\r\n[caption id=\"\" align=\"aligncenter\" width=\"585\"]<img src=\"https:\/\/s3-us-west-2.amazonaws.com\/courses-images\/wp-content\/uploads\/sites\/2042\/2018\/02\/05153741\/CNX_Econ_C13_004.jpg\" alt=\"The graph shows the market for flu shots: flu shots will go under produced because the market does not recognize their positive externality. If the government provides a subsidy to consumers of flu shots, equal to the marginal social benefit minus the marginal private benefit, the level of vaccinations can increase to the socially optimal quantity of QSocial.\" width=\"585\" height=\"347\" \/> <strong>Figure 3. The Market for Flu Shots with Spillover Benefits (A Positive Externality).<\/strong> The market demand curve does not reflect the positive externality of flu vaccinations, so only Q<sub>Market<\/sub> will be exchanged. This outcome is inefficient because the marginal social benefit exceeds the marginal social cost. If the government provides a subsidy to consumers of flu shots, equal to the marginal social benefit minus the marginal private benefit, the level of vaccinations can increase to the socially optimal quantity of Q<sub>Social<\/sub>.[\/caption]\r\n\r\n<div class=\"textbox examples\">\r\n<h3>Watch IT<\/h3>\r\nWatch this video to see how positive externalities increase the overall social benefits to society and cause the supply and demand graph to change.\r\n\r\n<iframe src=\"https:\/\/www.youtube.com\/embed\/TSTLLFJbaA4?rel=0&amp;showinfo=0\" width=\"800\" height=\"470\" frameborder=\"0\"><\/iframe>\r\n\r\n<\/div>\r\n<div class=\"textbox tryit\">\r\n<h3>Try It<\/h3>\r\nThese questions allow you to get as much practice as you need, as you can click the link at the top of the first question (\u201cTry another version of these questions\u201d) to get a new set of questions. Practice until you feel comfortable doing the questions.\r\n\r\n[ohm_question height=\"1000\"]276561[\/ohm_question]<\/div>\r\n<div class=\"textbox learning-objectives\">\r\n<h3>Glossary<\/h3>\r\n[glossary-page][glossary-term]external benefits (or positive externalities):[\/glossary-term]\r\n[glossary-definition]beneficial spillovers to a third party of parties, who did not purchase the good or service that provided the externalities[\/glossary-definition]\r\n[glossary-term]marginal private\u00a0benefits (MPB):[\/glossary-term][glossary-definition]the benefits obtained by consumers from purchasing additional units of some product; shown by the market demand curve[\/glossary-definition]\r\n[glossary-term]marginal social benefits (MSP):[\/glossary-term][glossary-definition]the sum of the private and external benefits when additional units of some product are purchased; also known as the social demand curve[\/glossary-definition][glossary-term]positive externalities:[\/glossary-term]\r\n[glossary-definition]beneficial spillovers to a third party or parties[\/glossary-definition][glossary-term]private benefits:[\/glossary-term]\r\n[glossary-definition]the benefits a person who consumes a good or service receives, or a new product's benefits or process that a company invents that the company captures[\/glossary-definition][glossary-term]private rates of return:[\/glossary-term]\r\n[glossary-definition]when the estimated rates of return go primarily to an individual; for example, earning interest on a savings account[\/glossary-definition][glossary-term]social benefits:[\/glossary-term]\r\n[glossary-definition]the sum of private benefits and external benefits[\/glossary-definition][glossary-term]social rate of return:[\/glossary-term]\r\n[glossary-definition]when the estimated rates of return go primarily to society; for example, providing free education[\/glossary-definition][\/glossary-page]\r\n\r\n<\/div>","rendered":"<div class=\"textbox learning-objectives\">\n<h3>Learning Objectives<\/h3>\n<ul>\n<li>Identify and explain positive externalities, including new technology<\/li>\n<li>Show how differences between private benefits and social benefits cause market failure<\/li>\n<\/ul>\n<\/div>\n<p>Individual demand reflects the marginal benefits a consumer receives from some product. When we sum all individual demands, we get the market demand. Market demand captures the <strong>marginal private benefits<\/strong>\u00a0(MPB) of the product, since it measures the benefits received by the consumers who purchase the product.\u00a0Figure 1 shows the market demand curve as MPB.<\/p>\n<div id=\"attachment_9166\" style=\"width: 561px\" class=\"wp-caption aligncenter\"><img loading=\"lazy\" decoding=\"async\" aria-describedby=\"caption-attachment-9166\" class=\"wp-image-9166\" src=\"https:\/\/s3-us-west-2.amazonaws.com\/courses-images\/wp-content\/uploads\/sites\/2042\/2018\/02\/05200545\/MPB.jpg\" alt=\"Two demand curves. The first is the private demand, or MPB, and the second shows that MPB plus external benefits equals the MSB.\" width=\"551\" height=\"413\" \/><\/p>\n<p id=\"caption-attachment-9166\" class=\"wp-caption-text\"><strong>Figure 1.<\/strong> Marginal private benefits plus external benefits equal marginal social benefits.<\/p>\n<\/div>\n<p>Some products provide both private and external benefits. <strong>External benefits<\/strong> are benefits received by someone who didn\u2019t purchase the product, but received some benefits as a spillover or side effect of the consumer\u2019s purchasing the product. When external benefits exist, we describe the situation as a <strong>positive externality<\/strong>, where the marginal benefit to society is greater than the marginal benefits to the consumers who purchased the product. The <strong>marginal social benefits (MSB)<\/strong> are the marginal private benefits plus the external benefits. Figure 1 shows the social demand curve as MSB.\u00a0Failure to consider those external benefits results in a market failure. In this section we examine some examples.<\/p>\n<h2>Positive Externalities and Private Benefits<\/h2>\n<p>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. As Gregory Lee, CEO of Samsung said, &#8220;Relentless pursuit of new innovation is the key principle of our business and enables consumers to discover a world of possibilities with technology.&#8221; An innovative firm knows that it will usually have a temporary edge over its competitors and thus an ability to earn above-normal profits before competitors can catch up.<\/p>\n<p>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. On average, it can cost $800 million and take more than a decade to discover a new drug, perform the necessary safety tests, and bring the drug to market. If the research and development (R&amp;D) effort fails\u2014and every R&amp;D project has some chance of failure\u2014then the firm will suffer losses and could even be driven out of business. If the project succeeds, then the firm&#8217;s competitors may figure out ways of adapting and copying the underlying idea, but without having to pay the costs themselves. As a result, the innovative company will bear the much higher costs of the R&amp;D and will enjoy at best only a small, temporary advantage over the competition.<\/p>\n<p>Many inventors over the years have discovered that their inventions brought them less profit than they might have reasonably expected.<\/p>\n<ul>\n<li>Eli Whitney (1765\u20131825) invented the cotton gin, but then southern cotton planters built their own seed-separating devices with a few minor changes in Whitney&#8217;s design. When Whitney sued, he found that the courts in southern states would not uphold his patent rights.<\/li>\n<li>Thomas Edison (1847\u20131931) still holds the record for most patents granted to an individual. His first invention was an automatic vote counter, and despite the social benefits, he could not find a government that wanted to buy it.<\/li>\n<li>Gordon Gould (1920\u20132005) came up with the idea behind the laser in 1957. He put off applying for a patent and, by the time he did apply, other scientists had laser inventions of their own. A lengthy legal battle resulted, in which Gould spent $100,000 on lawyers, before he eventually received a patent for the laser in 1977. Compared to the enormous social benefits of the laser, Gould received relatively little financial reward.<\/li>\n<\/ul>\n<p>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.<\/p>\n<h2>Positive Externalities of New Technology<\/h2>\n<p>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 <strong>private benefits<\/strong>, or profits, that the firm receives are only a portion of the overall social benefits. The <strong>social benefits<\/strong> 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. <strong>Positive externalities<\/strong> are beneficial spillovers to a third party, or parties.<\/p>\n<p>Consider the example of the Big Drug Company, which is planning its R&amp;D budget for the next year. Economists and scientists working for Big Drug have compiled a list of potential research and development projects and estimated rates of return. (The <strong>rate of return<\/strong> is the estimated payoff from the project.) Figure 2 shows how the calculations work. The downward-sloping D<sub>Private<\/sub> curve represents the firm\u2019s demand for financial capital and reflects the company\u2019s willingness to borrow to finance research and development projects at various interest rates. Suppose that this firm\u2019s investment in research and development creates a spillover benefit to other firms and households. After all, new innovations often spark other creative endeavors that society also values. If we add the spillover benefits society enjoys to the firm\u2019s private demand for financial capital, we can draw D<sub>Social<\/sub> that lies above D<sub>Private<\/sub>.<\/p>\n<div style=\"width: 467px\" class=\"wp-caption aligncenter\"><img loading=\"lazy\" decoding=\"async\" class=\"\" src=\"https:\/\/s3-us-west-2.amazonaws.com\/courses-images\/wp-content\/uploads\/sites\/2042\/2018\/02\/05153738\/CNX_Econ_C13_002.jpg\" alt=\"The graph shows the different demand curves based on whether or not a firm receives social benefits in addition to private benefits.\" width=\"457\" height=\"295\" \/><\/p>\n<p class=\"wp-caption-text\"><strong>Figure 2.<\/strong> <strong>Positive Externalities and Technology.<\/strong> Big Drug faces a cost of borrowing of 8%. If the firm receives only the private benefits of investing in R&amp;D, then its demand curve for financial capital is shown by D<sub>Private<\/sub>, and the equilibrium will occur at $30 million. Because there are spillover benefits, society would find it optimal to have $52 million of investment. If the firm could keep the social benefits of its investment for itself, its demand curve for financial capital would be D<sub>Social<\/sub> and it would be willing to borrow $52 million.<\/p>\n<\/div>\n<p>If there was a way for the firm to fully monopolize those social benefits by somehow making them unavailable to the rest of us, the firm&#8217;s private demand curve would be the same as society&#8217;s demand curve. According to Figure 2 and Table 1, if the going rate of interest on borrowing is 8%, and the company can receive the private benefits of innovation only, then the company would finance $30 million. Society, at the same rate of 8%, would find it optimal to have $52 million of borrowing. Unless there is a way for the company to fully enjoy the total benefits, then it will borrow less than the socially optimal level of $52 million.<\/p>\n<table id=\"ch13mod01_tab01\" summary=\"This table has three columns and six rows. The first row is a header row, and it labels the columns, 'Rates of Return', 'D_{Private} (in millions)', and 'D_{Social} (in millions)'. Under the column 'Rate of Return' are the following values: 2%, 4%, 6%, 8%, and 10%. Under the 'D_{Private} (in millions)' column are the following values: $72, $52, $38, $30, and $26. Under the 'D_{Social} (in millions)' column are the following values: $84, $72, $62, $52, and $44.\">\n<thead>\n<tr>\n<th colspan=\"3\">Table 1. Return and Demand for Capital<\/th>\n<\/tr>\n<\/thead>\n<tbody>\n<tr>\n<th>Rate of Return<\/th>\n<th>D<sub>Private<\/sub> (in millions)<\/th>\n<th>D<sub>Social<\/sub> (in millions)<\/th>\n<\/tr>\n<tr>\n<td>2%<\/td>\n<td>$72<\/td>\n<td>$84<\/td>\n<\/tr>\n<tr>\n<td>4%<\/td>\n<td>$52<\/td>\n<td>$72<\/td>\n<\/tr>\n<tr>\n<td>6%<\/td>\n<td>$38<\/td>\n<td>$62<\/td>\n<\/tr>\n<tr>\n<td>8%<\/td>\n<td>$30<\/td>\n<td>$52<\/td>\n<\/tr>\n<tr>\n<td>10%<\/td>\n<td>$26<\/td>\n<td>$44<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<p>Big Drug&#8217;s original demand for financial capital (D<sub>Private<\/sub>) is based on the profits received by the firm. 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. If Big Drug were able to gain this social return instead of other companies, its demand for financial capital would shift to the demand curve D<sub>Social<\/sub>, and it would be willing to borrow and invest $52 million. 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<sub>Private<\/sub> and D<sub>Social<\/sub>.<\/p>\n<div class=\"textbox tryit\">\n<h3>Try It<\/h3>\n<p>\t<iframe id=\"assessment_practice_9a05c049-c618-4b42-a658-91a95d17435e\" class=\"resizable\" src=\"https:\/\/assess.lumenlearning.com\/practice\/9a05c049-c618-4b42-a658-91a95d17435e?iframe_resize_id=assessment_practice_id_9a05c049-c618-4b42-a658-91a95d17435e\" frameborder=\"0\" style=\"border:none;width:100%;height:100%;min-height:300px;\"><br \/>\n\t<\/iframe><\/p>\n<p>\t<iframe id=\"assessment_practice_ddfee036-7c8c-4282-add9-39a83476a64e\" class=\"resizable\" src=\"https:\/\/assess.lumenlearning.com\/practice\/ddfee036-7c8c-4282-add9-39a83476a64e?iframe_resize_id=assessment_practice_id_ddfee036-7c8c-4282-add9-39a83476a64e\" frameborder=\"0\" style=\"border:none;width:100%;height:100%;min-height:300px;\"><br \/>\n\t<\/iframe><\/p>\n<\/div>\n<h2>Why Invest in Human Capital?<\/h2>\n<p>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. Over the span of many years, a student and her family invest significant amounts of time and money into that student&#8217;s education. The idea is that higher levels of educational attainment will eventually serve to increase the student&#8217;s future productivity and subsequent ability to earn. Once the numbers are crunched, does this investment pay off for the student?<\/p>\n<p id=\"fs-idm175347168\">Almost universally, economists have found that the answer to this question is a clear &#8220;Yes.&#8221; For example, several studies of the return to education in the United States estimate that the rate of return to a college education is approximately 10-15%. Data in Table 2, from the U.S. Bureau of Labor Statistics\u2019 <em>Usual Weekly Earnings of Wage and Salary Workers, Third Quarter 2016,<\/em> demonstrate that median weekly earnings are higher for workers who have completed more education. While these rates of return will beat equivalent investments in Treasury bonds or savings accounts, the estimated returns to education go primarily to the individual worker, so these returns are private rates of return to education.<\/p>\n<table id=\"ch13mod01_tab02\" summary=\"This table has four columns and one row. The first row is a header row and it labels the last three columns, 'Less than a High School Degree,' 'High School Degree, No College,' and 'Bachelor's Degree.' Under the 'Less than a High School Degree' column is the value: $488. Under the 'High School Degree, No College' column is the value: $668. Under the 'Bachelor's Degree' column is the value: ,101.\">\n<caption>Table 2. Usual Weekly Earnings of Wage and Salary Workers, Fourth Quarter 2016\u00a0(Source: http:\/\/www.bls.gov\/news.release\/pdf\/wkyeng.pdf)<\/caption>\n<thead>\n<tr>\n<th><\/th>\n<th>Less than a High School Degree<\/th>\n<th>High School Degree, No College<\/th>\n<th>Bachelor\u2019s Degree<\/th>\n<\/tr>\n<\/thead>\n<tbody>\n<tr>\n<td>Median Weekly Earnings (full-time workers over the age of 25)<\/td>\n<td>$519<\/td>\n<td>$698<\/td>\n<td>$1,270<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<p>What does society gain from investing in the education of another student? After all, if the government is spending taxpayer dollars to subsidize public education, society should expect some kind of return on that spending. Economists like\u00a0<span class=\"no-emphasis\">George Psacharopoulos<\/span>\u00a0have found that, across a variety of nations, the\u00a0social rate of return\u00a0on schooling is also positive. After all, positive externalities exist from investment in education. While not always easy to measure, according to\u00a0<span class=\"no-emphasis\">Walter McMahon<\/span>, the positive externalities to education typically include better health outcomes for the population, lower levels of crime, a cleaner environment and a more stable, democratic government. For these reasons, many nations have chosen to use taxpayer dollars to subsidize primary, secondary, and higher education. Education clearly benefits the person who receives it, but a society where most people have a good level of education provides positive externalities for all.<\/p>\n<h2>Other Examples of Positive Externalities<\/h2>\n<p>Although technology may be the most prominent example of a positive externality, it is not the only one. For example, being vaccinated against disease is not only a protection for the individual, but it has the positive spillover of protecting others who may become infected. When a number of homes in a neighborhood are modernized, updated, and restored, not only does it increase the value of those homes, but the value of other properties in the neighborhood may increase as well.<\/p>\n<p id=\"fs-idm108426544\">Figure 3 shows the market for flu shots. The market demand curve D<sub>Market<\/sub> for flu shots reflects only the marginal private benefits (MPB) that the vaccinated individuals receive from the shots. Assuming that there are no spillover costs in the production of flu shots, the market supply curve is given by the marginal private cost (MPC) of producing the vaccinations.<\/p>\n<p id=\"fs-idm109011616\">The equilibrium quantity of flu shots produced in the market, where MPB is equal to MPC, is Q<sub>Market<\/sub> and the price of flu shots is P<sub>Market<\/sub>. However, spillover benefits exist in this market because others, those who chose not to purchase a flu shot, receive a positive externality in a reduced chance of contracting the flu. When we add the spillover benefits to the marginal private benefit of flu shots, the marginal social benefit (MSB) of flu shots is given by D<sub>Social<\/sub>. Because the MSB is greater than MPB, we see that the socially optimal level of flu shots is greater than the market quantity (Q<sub>Social<\/sub> exceeds Q<sub>Market<\/sub>) and the corresponding price of flu shots, if the market were to produce Q<sub>Social<\/sub>, would be at P<sub>Social<\/sub>. Unfortunately, the marketplace does not recognize the positive externality and flu shots will go under produced and under consumed.<\/p>\n<p id=\"fs-idm165710736\">How can government try to move the market level of output closer to the socially desirable level of output? One policy would be to provide a subsidy, like a voucher, to any citizen who wishes to get vaccinated. This voucher would act as &#8220;income&#8221; that one could use purchase only a flu shot and, if the voucher were exactly equal to the per-unit spillover benefits, would increase market equilibrium to a quantity of Q<sub>Social<\/sub> and a price of P<sub>Social<\/sub> where MSB equals MSC. Suppliers of the flu shots would receive payment of P<sub>Social<\/sub> per vaccination, while consumers of flu shots would redeem the voucher and only pay a price of P<sub>Subsidy<\/sub>. When the government uses a subsidy in this way, it produces the socially optimal quantity of vaccinations.<\/p>\n<div style=\"width: 595px\" class=\"wp-caption aligncenter\"><img loading=\"lazy\" decoding=\"async\" src=\"https:\/\/s3-us-west-2.amazonaws.com\/courses-images\/wp-content\/uploads\/sites\/2042\/2018\/02\/05153741\/CNX_Econ_C13_004.jpg\" alt=\"The graph shows the market for flu shots: flu shots will go under produced because the market does not recognize their positive externality. If the government provides a subsidy to consumers of flu shots, equal to the marginal social benefit minus the marginal private benefit, the level of vaccinations can increase to the socially optimal quantity of QSocial.\" width=\"585\" height=\"347\" \/><\/p>\n<p class=\"wp-caption-text\"><strong>Figure 3. The Market for Flu Shots with Spillover Benefits (A Positive Externality).<\/strong> The market demand curve does not reflect the positive externality of flu vaccinations, so only Q<sub>Market<\/sub> will be exchanged. This outcome is inefficient because the marginal social benefit exceeds the marginal social cost. If the government provides a subsidy to consumers of flu shots, equal to the marginal social benefit minus the marginal private benefit, the level of vaccinations can increase to the socially optimal quantity of Q<sub>Social<\/sub>.<\/p>\n<\/div>\n<div class=\"textbox examples\">\n<h3>Watch IT<\/h3>\n<p>Watch this video to see how positive externalities increase the overall social benefits to society and cause the supply and demand graph to change.<\/p>\n<p><iframe loading=\"lazy\" src=\"https:\/\/www.youtube.com\/embed\/TSTLLFJbaA4?rel=0&amp;showinfo=0\" width=\"800\" height=\"470\" frameborder=\"0\"><\/iframe><\/p>\n<\/div>\n<div class=\"textbox tryit\">\n<h3>Try It<\/h3>\n<p>These questions allow you to get as much practice as you need, as you can click the link at the top of the first question (\u201cTry another version of these questions\u201d) to get a new set of questions. Practice until you feel comfortable doing the questions.<\/p>\n<p><iframe loading=\"lazy\" id=\"ohm276561\" class=\"resizable\" src=\"https:\/\/ohm.lumenlearning.com\/multiembedq.php?id=276561&theme=oea&iframe_resize_id=ohm276561&show_question_numbers\" width=\"100%\" height=\"1000\"><\/iframe><\/div>\n<div class=\"textbox learning-objectives\">\n<h3>Glossary<\/h3>\n<div class=\"titlepage\">\n<dl>\n<dt>external benefits (or positive externalities):<\/dt>\n<dd>beneficial spillovers to a third party of parties, who did not purchase the good or service that provided the externalities<\/dd>\n<dt>marginal private\u00a0benefits (MPB):<\/dt>\n<dd>the benefits obtained by consumers from purchasing additional units of some product; shown by the market demand curve<\/dd>\n<dt>marginal social benefits (MSP):<\/dt>\n<dd>the sum of the private and external benefits when additional units of some product are purchased; also known as the social demand curve<\/dd>\n<dt>positive externalities:<\/dt>\n<dd>beneficial spillovers to a third party or parties<\/dd>\n<dt>private benefits:<\/dt>\n<dd>the benefits a person who consumes a good or service receives, or a new product&#8217;s benefits or process that a company invents that the company captures<\/dd>\n<dt>private rates of return:<\/dt>\n<dd>when the estimated rates of return go primarily to an individual; for example, earning interest on a savings account<\/dd>\n<dt>social benefits:<\/dt>\n<dd>the sum of private benefits and external benefits<\/dd>\n<dt>social rate of return:<\/dt>\n<dd>when the estimated rates of return go primarily to society; for example, providing free education<\/dd>\n<\/dl>\n<\/div>\n<\/div>\n\n\t\t\t <section class=\"citations-section\" role=\"contentinfo\">\n\t\t\t <h3>Candela Citations<\/h3>\n\t\t\t\t\t <div>\n\t\t\t\t\t\t <div id=\"citation-list-6546\">\n\t\t\t\t\t\t\t <div class=\"licensing\"><div class=\"license-attribution-dropdown-subheading\">CC licensed content, Original<\/div><ul class=\"citation-list\"><li>Modification, adaptation, and original content. <strong>Provided by<\/strong>: Lumen Learning. <strong>License<\/strong>: <em><a target=\"_blank\" rel=\"license\" href=\"https:\/\/creativecommons.org\/licenses\/by\/4.0\/\">CC BY: Attribution<\/a><\/em><\/li><\/ul><div class=\"license-attribution-dropdown-subheading\">CC licensed content, Shared previously<\/div><ul class=\"citation-list\"><li>Why the Private Sector Underinvests in Innovation. <strong>Authored by<\/strong>: OpenStax College. <strong>Located at<\/strong>: <a target=\"_blank\" href=\"https:\/\/cnx.org\/contents\/vEmOH-_p@4.44:TwbO_eSX@4\/Why-the-Private-Sector-Underin\">https:\/\/cnx.org\/contents\/vEmOH-_p@4.44:TwbO_eSX@4\/Why-the-Private-Sector-Underin<\/a>. <strong>License<\/strong>: <em><a target=\"_blank\" rel=\"license\" href=\"https:\/\/creativecommons.org\/licenses\/by\/4.0\/\">CC BY: Attribution<\/a><\/em>. <strong>License Terms<\/strong>: Download for free at http:\/\/cnx.org\/contents\/bc498e1f-efe9-43a0-8dea-d3569ad09a82@4.44<\/li><\/ul><div class=\"license-attribution-dropdown-subheading\">All rights reserved content<\/div><ul class=\"citation-list\"><li>Positive externalities | Consumer and producer surplus | Microeconomics | Khan Academy. <strong>Provided by<\/strong>: Khan Academy. <strong>Located at<\/strong>: <a target=\"_blank\" href=\"https:\/\/www.youtube.com\/watch?v=TSTLLFJbaA4\">https:\/\/www.youtube.com\/watch?v=TSTLLFJbaA4<\/a>. <strong>License<\/strong>: <em>Other<\/em>. <strong>License Terms<\/strong>: Standard YouTube License<\/li><\/ul><\/div>\n\t\t\t\t\t\t <\/div>\n\t\t\t\t\t <\/div>\n\t\t\t <\/section>","protected":false},"author":29,"menu_order":7,"template":"","meta":{"_candela_citation":"[{\"type\":\"cc\",\"description\":\"Why the Private Sector Underinvests in Innovation\",\"author\":\"OpenStax College\",\"organization\":\"\",\"url\":\"https:\/\/cnx.org\/contents\/vEmOH-_p@4.44:TwbO_eSX@4\/Why-the-Private-Sector-Underin\",\"project\":\"\",\"license\":\"cc-by\",\"license_terms\":\"Download for free at http:\/\/cnx.org\/contents\/bc498e1f-efe9-43a0-8dea-d3569ad09a82@4.44\"},{\"type\":\"copyrighted_video\",\"description\":\"Positive externalities | Consumer and producer surplus | Microeconomics | Khan Academy\",\"author\":\"\",\"organization\":\"Khan Academy\",\"url\":\"https:\/\/www.youtube.com\/watch?v=TSTLLFJbaA4\",\"project\":\"\",\"license\":\"other\",\"license_terms\":\"Standard YouTube License\"},{\"type\":\"original\",\"description\":\"Modification, adaptation, and original content\",\"author\":\"\",\"organization\":\"Lumen Learning\",\"url\":\"\",\"project\":\"\",\"license\":\"cc-by\",\"license_terms\":\"\"}]","CANDELA_OUTCOMES_GUID":"3eb20152-5734-4fca-a96d-f700aa7e26a4, da9934a7-7114-4a76-b0b9-9b9f15026c79, 90cd420d-2c66-450d-a0c5-476423bbfa25","pb_show_title":"on","pb_short_title":"","pb_subtitle":"","pb_authors":[],"pb_section_license":""},"chapter-type":[],"contributor":[],"license":[],"class_list":["post-6546","chapter","type-chapter","status-publish","hentry"],"part":6533,"_links":{"self":[{"href":"https:\/\/courses.lumenlearning.com\/wm-microeconomics\/wp-json\/pressbooks\/v2\/chapters\/6546","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/courses.lumenlearning.com\/wm-microeconomics\/wp-json\/pressbooks\/v2\/chapters"}],"about":[{"href":"https:\/\/courses.lumenlearning.com\/wm-microeconomics\/wp-json\/wp\/v2\/types\/chapter"}],"author":[{"embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/wm-microeconomics\/wp-json\/wp\/v2\/users\/29"}],"version-history":[{"count":38,"href":"https:\/\/courses.lumenlearning.com\/wm-microeconomics\/wp-json\/pressbooks\/v2\/chapters\/6546\/revisions"}],"predecessor-version":[{"id":10231,"href":"https:\/\/courses.lumenlearning.com\/wm-microeconomics\/wp-json\/pressbooks\/v2\/chapters\/6546\/revisions\/10231"}],"part":[{"href":"https:\/\/courses.lumenlearning.com\/wm-microeconomics\/wp-json\/pressbooks\/v2\/parts\/6533"}],"metadata":[{"href":"https:\/\/courses.lumenlearning.com\/wm-microeconomics\/wp-json\/pressbooks\/v2\/chapters\/6546\/metadata\/"}],"wp:attachment":[{"href":"https:\/\/courses.lumenlearning.com\/wm-microeconomics\/wp-json\/wp\/v2\/media?parent=6546"}],"wp:term":[{"taxonomy":"chapter-type","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/wm-microeconomics\/wp-json\/pressbooks\/v2\/chapter-type?post=6546"},{"taxonomy":"contributor","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/wm-microeconomics\/wp-json\/wp\/v2\/contributor?post=6546"},{"taxonomy":"license","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/wm-microeconomics\/wp-json\/wp\/v2\/license?post=6546"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}