Under-consumption happens when a good creates benefits for people other than the buyer, and buyers ignore those benefits. The market then settles at a quantity below the one that would suit society most.
This lesson follows separating private from external costs, but looks at the mirror image: an external benefit. It sits inside market failure concepts.
What does the model say?
A “stated model” means you work with the lines you are given and do not add your own. Three ideas carry the whole argument.
- MPB (marginal private benefit) is what one more unit is worth to the buyer. It slopes down.
- MC (marginal cost) is what one more unit costs to supply, assumed here to be fully paid by the producer.
- MSB (marginal social benefit) is MPB plus the external benefit per unit. It sits above MPB by that amount.
The market quantity is where MPB = MC, because buyers and sellers only see their own sides. The social optimum is where MSB = MC.
Worked example: first-aid evening classes
In the fictional town of Bandar Selatan, a community centre sells first-aid places. Quantity is places per month. Money is RM per place.
- MPB = 100 − Q
- MC = 20 + Q
- External benefit = RM 20 per place (a trained person can help neighbours in an emergency, and those neighbours do not pay).
So MSB = 120 − Q.
| Q (places) | MPB | MSB | MC |
|---|---|---|---|
| 30 | 70 | 90 | 50 |
| 40 | 60 | 80 | 60 |
| 50 | 50 | 70 | 70 |
| 60 | 40 | 60 | 80 |
Step 1, market outcome. MPB = MC: 100 − Q = 20 + Q, so 2Q = 80 and Q = 40. Price = 60.
Step 2, social optimum. MSB = MC: 120 − Q = 20 + Q, so 2Q = 100 and Q = 50. At 50, MSB = MC = 70.
Step 3, under-consumption. 50 − 40 = 10 places.
Step 4, size of the loss. At Q = 40, MSB is 80 and MC is 60, a gap of 20 per place. The gap shrinks to 0 at Q = 50. The welfare loss is the triangle ½ × 10 × 20 = RM 100 per month.
Step 5, write it up. Buyers weigh only their own benefit of RM 60 at the margin. The extra RM 20 benefit to neighbours is ignored, so the 41st to 50th places are not bought even though each is worth more to society than it costs.
The mistake to watch for
Mistaken answer: “The social optimum is at Q = 40 where MPB meets MC, and Q = 50 is over-production.”
The student has used the wrong benefit curve. MPB = MC gives the market quantity. The social optimum uses MSB.
Correction: the social optimum is the larger quantity, 50. The market quantity, 40, is too low. A quick check is the direction of the externality. A positive externality lifts MSB above MPB, so the optimum is further right.
Check yourself
Use the first-aid model above.
1. At Q = 45, what is the gap between MSB and MC?
Show answer
MSB = 120 − 45 = 75. MC = 20 + 45 = 65. The gap is RM 10, which sits halfway between the 20 gap at 40 and the 0 gap at 50.
2. Suppose the external benefit were RM 10 instead of 20. Find the social optimum.
Show answer
MSB = 110 − Q. Set 110 − Q = 20 + Q, so 2Q = 90 and Q = 45. Under-consumption is 45 − 40 = 5 places.
3. Why is a positive externality called a market failure even though buyers and sellers both agree on the price?
Show answer
Because the price reflects only the private benefit. A third party gains benefit that nobody pays for, so the quantity traded is lower than the quantity that would make the most efficient use of resources.
Where this leads next
Next, test the idea on goods that nobody can be stopped from enjoying in interpreting a public-good example. The percentage-base explorer is handy when a question gives the benefit as a percentage of price.
If drawing and labelling the curves under time pressure is where marks slip, online one-to-one Economics tuition lets a teacher watch you build the diagram step by step.