In the presence of a positive externality in consumption, the market outcome is associated with which of the following?

• A. A welfare loss arising from underproduction relative to the social optimum
• B. A welfare gain from overconsumption
• C. No welfare effects from externalities
• D. A welfare loss arising from overconsumption

Answer: (D)

A positive externality in consumption means the benefit from consuming a unit spills over to others, so the social marginal benefit is higher than the private marginal benefit faced by the consumer. Because the market price captures only the private benefit, the equilibrium quantity is below the socially optimal quantity. The resulting welfare loss comes from underproduction: there are additional units that would add more to society than they cost, but they aren’t produced in the private market. Overconsumption would occur if the externality were negative or if the social cost exceeded the private cost. In cases like vaccines or education, subsidies or public provision can help move output toward the social optimum.