In a perfectly competitive industry at long-run equilibrium, if the production of a good generates positive externalities, the private market will produce

• A. more than socially optimum amount
• B. exactly socially optimum amount
• C. not produced
• D. less than socially optimum amount

Answer: (D)

Positive externalities mean the social payoff from producing a unit is higher than the private payoff captured by the producer. In a perfectly competitive industry at long-run equilibrium, firms produce where price equals private marginal cost, so output is guided by private marginal benefits. Because the social marginal benefit exceeds the private marginal benefit, the level of output that maximizes social welfare is larger than what the private market produces. Therefore the private market will underproduce relative to the socially optimal amount. The socially optimal quantity would be where social marginal benefit equals marginal social cost, and government tools like subsidies or public provision can help align private incentives with the social value to reach that level.