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Chapter 5: Problem 8

In 2017, President Donald Trump was considering a major increase on federal government spending on infrastructure, including building and repairing bridges, highways, rail lines, and subways. An article in the Economist argued, "Just as economists talk of 'negative externalities' (from, say, pollution), infrastructure can have positive externalities that are not captured by investors but will benefit society." a. Explain what positive externalities infrastructure spending might generate. b. If infrastructure spending generates a positive externality, what effect should this have on government policy?

Short Answer

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Infrastructure spending can generate positive externalities such as increased business productivity owing to better transport networks, or enhancement of property values due to better public utilities. These are benefits that are not captured by the market price. When these positive externalities exist, it implies that market forces alone will not result in an optimal level of infrastructure because they do not account for these positive external benefits. This means government intervention is necessary, either via subsidies or direct investment, to ensure these benefits are realized.

Step by step solution

01

Understanding Positive Externalities

Positive externalities are additional benefits that an individual or society receives from a product or service, but that are not accounted for in the market price. In the context of infrastructure spending, positive externalities might include the increased productivity of businesses owing to improved transportation networks, or the enhancement of property values in areas that gain better access to public utilities.
02

Effects of Positive Externalities

If a positive externality is present, the social benefit from a good or service exceeds the private benefit. Due to these external benefits, the product or service will be under-consumed and under-produced in a freely functioning market. The reason is that the individuals or firms producing the product or service do not have an incentive to factor in these external benefits while making their production decision.
03

Positive Externalities and Government Policy

If infrastructure spending generates a positive externality, it implies that market forces alone will not lead to an optimal level of infrastructure. This is because market forces do not account for the positive external benefits generated by infrastructure spending. As a result, this should lead to government intervention to increase the production and consumption of infrastructure. The government can do this by subsidizing infrastructure projects, for example, or by directly investing in infrastructure itself.

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