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13.E: Positive Externalities and Public Goods (Key Concepts and Exercises)

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    Key Concepts

    13.1 Why the Private Sector Underinvests in Innovation

    Competition creates pressure to innovate. However, if one can easily copy new inventions, then the original inventor loses the incentive to invest further in research and development. New technology often has positive externalities; that is, there are often spillovers from the invention of new technology that benefit firms other than the innovator. The social benefit of an invention, once the firm accounts for these spillovers, typically exceeds the private benefit to the inventor. If inventors could receive a greater share of the broader social benefits for their work, they would have a greater incentive to seek out new inventions.

    13.2 How Governments Can Encourage Innovation

    Public policy with regard to technology must often strike a balance. For example, patents provide an incentive for inventors, but they should be limited to genuinely new inventions and not extend forever.

    Government has a variety of policy tools for increasing the rate of return for new technology and encouraging its development, including: direct government funding of R&D, tax incentives for R&D, protection of intellectual property, and forming cooperative relationships between universities and the private sector.

    13.3 Public Goods

    A public good has two key characteristics: it is nonexcludable and non-rival. Nonexcludable means that it is costly or impossible for one user to exclude others from using the good. Non-rival means that when one person uses the good, it does not prevent others from using it. Markets often have a difficult time producing public goods because free riders will attempt to use the public good without paying for it. One can overcome the free rider problem through measures to assure that users of the public good pay for it. Such measures include government actions, social pressures, and specific situations where markets have discovered a way to collect payments.


    1. Do market demand curves reflect positive externalities? Why or why not?

    2. Suppose that Sony's R&D investment in digital devices has increased profits by 20%. Is this a private or social benefit?

    3. The Gizmo Company is planning to develop new household gadgets. Table \(\PageIndex{1}\) shows the company’s demand for financial capital for research and development of these gadgets, based on expected rates of return from sales. Now, say that every investment would have an additional 5% social benefit—that is, an investment that pays at least a 6% return to the Gizmo Company will pay at least an 11% return for society as a whole; an investment that pays at least 7% for the Gizmo Company will pay at least 12% for society as a whole, and so on. Answer the questions that follow based on this information.

    Estimated Rate of Return Private profits of the firm from an R&D project (in $ millions)
    10% $100
    9% $102
    8% $108
    7% $118
    6% $133
    5% $153
    4% $183
    3% $223

    Table \(\PageIndex{1}\)

    If the going interest rate is 9%, how much will Gizmo invest in R&D if it receives only the private benefits of this investment?

    4. Assume that the interest rate is still 9%. How much will the firm invest if it also receives the social benefits of its investment? (Add an additional 5% return on all levels of investment.)


    5. The Junkbuyers Company travels from home to home, looking for opportunities to buy items that would otherwise end up with the garbage, but which the company can resell or recycle. Which will be larger, the private or the social benefits?

    6. When residents in a neighborhood tidy it and keep it neat, there are a number of positive spillovers: higher property values, less crime, happier residents. What types of government policies can encourage neighborhoods to clean up?

    7. Education provides both private benefits to those who receive it and broader social benefits for the economy as a whole. Think about the types of policies a government can follow to address the issue of positive spillovers in technology and then suggest a parallel set of policies that governments could follow for addressing positive externalities in education.

    8. Which of the following goods or services are nonexcludable?

    1. police protection
    2. streaming music from satellite transmission programs
    3. roads
    4. primary education
    5. cell phone service

    9. Are the following goods non-rival in consumption?

    1. slice of pizza
    2. laptop computer
    3. public radio
    4. ice cream cone
    10. In what ways do company investments in research and development create positive externalities?

    11. Will the demand for borrowing and investing in R&D be higher or lower if there are no external benefits?

    12. Why might private markets tend to provide too few incentives for the development of new technology?

    13. What can government do to encourage the development of new technology?

    14. What are the two key characteristics of public goods?

    15. Name two public goods and explain why they are public goods.

    16. What is the free rider problem?

    17. Explain why the federal government funds national defense.

    18. Can a company be guaranteed all of the social benefits of a new invention? Why or why not?

    19. Is it inevitable that government must become involved in supporting investments in new technology?
    20. How do public television stations, like PBS, try to overcome the free rider problem?

    21. Why is a football game on ESPN a quasi-public good but a game on the NBC, CBS, or ABC is a public good?

    22. Provide two examples of goods/services that are classified as private goods/services even though they are provided by a federal government.

    23. Radio stations, tornado sirens, light houses, and street lights are all public goods in that all are nonrivalrous and nonexclusionary. Therefore why does the government provide tornado sirens, street lights and light houses but not radio stations (other than PBS stations)?

    13.E: Positive Externalities and Public Goods (Key Concepts and Exercises) is shared under a CC BY 4.0 license and was authored, remixed, and/or curated by OpenStax via source content that was edited to conform to the style and standards of the LibreTexts platform; a detailed edit history is available upon request.

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