In the presence of a positive externality in the consumption of a good, which statement best describes the private market's production relative to the social optimum?

• A. Less than the socially optimal quantity
• B. Equal to the socially optimal quantity
• C. More than the socially optimal quantity
• D. Exactly the quantity maximizing private profits

Answer: (A)

When there is a positive externality in consumption, the overall benefit to society from consuming an extra unit is higher than the private benefit felt by the consumer. In a private market, decisions are based only on private benefits and costs, so buyers overlook the extra value their consumption creates for others. This means the market quantity is smaller than the level that would maximize total social welfare. The socially optimal quantity requires more consumption than the private market would provide. So the private market underproduces relative to the social optimum. To fix this, policies like subsidies or public provision can help internalize the external benefit and push production toward the social optimum.