When a good has a positive externality, the free market tends to produce:

• A. Too little
• B. Too much
• C. Exactly the socially optimal quantity
• D. Impossible to know

Answer: (A)

Positive externalities occur when the production or consumption of a good creates benefits for people who aren’t the buyer or seller. In a free market, prices reflect only private costs and private benefits, so these extra social benefits are ignored. As a result, the quantity produced is lower than the socially optimal level where social marginal benefit equals social marginal cost. So the market tends to produce too little of such a good. Policies like subsidies, public provision, or tax incentives can help internalize the external benefit and push quantity toward the social optimum. Examples include education or vaccination, where society gains from higher consumption beyond what the market would provide.