When are SMB greater than PMB?

• A. When there are negative externalities.
• B. When markets perfectly internalize all externalities.
• C. When there are no externalities.
• D. When there are positive externalities.

Answer: (D)

When there are positive externalities, the total benefit to society from consuming an extra unit is larger than the benefit received by the individual buyer. That’s why social marginal benefit (SMB) exceeds private marginal benefit (PMB). The buyer only considers their own benefit, not the spillover benefits enjoyed by others, so the private valuation used in the market is smaller than the society’s valuation. As a result, SMB sits above PMB, signaling that society would gain more from an additional unit than the market account for. This often helps explain why public subsidies or other interventions are used to boost consumption up to the socially optimal level, since the market alone underprovides goods with positive externalities.