Positive Externalities and Education

In a free market, consumers only consider their own MPB when deciding how much to buy. They will consume until their $MPB$ equals the price ($P$), which represents the Marginal Social Cost (MSC). However, since they ignore the MEB, the market equilibrium quantity ($Q_{mkt}$) is always lower than the socially optimal quantity ($Q_{opt}$). This gap represents a Market Failure. Because we are missing out on units where the social benefit is higher than the cost, the economy suffers from Deadweight Loss (DWL). On a graph, this is the triangle pointing toward the socially optimal point, representing the 'lost' welfare of the units not produced.

To fix under-consumption, governments use Subsidies. A subsidy is a payment to either the consumer or the producer that lowers the effective price. The goal is to 'internalize the externality.' If the government provides a subsidy exactly equal to the Marginal External Benefit (MEB), the consumer's perceived benefit shifts upward to align with the MSB. This encourages the market to reach $Q_{opt}$. For example, public education is heavily subsidized because a literate, skilled workforce makes the entire country more productive and stable, far beyond the higher salary the individual student earns.