In the above diagram, due to external benefits, the MSB is higher than the MPB. As firms and consumers consider only private costs and benefits, the divergence between the MSB and the MPB of education results in under-consumption. These positive externalities lead to a divergence between the MSB and the MPB. It also contributes to the formulation of better government policies. For example, it leads to a more productive and innovative labour force which is beneficial to the wider community. The consumption of education produces positive externalities. The private benefits of education are the satisfaction derived by consumers such as the higher skills and knowledge which will lead to higher income. Assuming no negative externalities in education consumption, the MSC is equal to the MPC. Therefore, from consumers’ perspective, the MPC of education is the price that they pay for the unit of the good. These costs are passed on to consumers in the form of a positive price. The private costs of education are the costs of production incurred by firms such as the costs of materials and labour. External costs and benefits, or externalities, are costs and benefits of consumption or production experienced by society other than the producers or the consumers. This occurs when marginal social benefit (MSB) is equal to marginal social cost (MSC) where MSB is the sum of marginal private benefit (MPB) and marginal external benefit (MEB) and MSC is the sum of marginal private cost (MPC) and marginal external cost (MEC). Allocative efficiency is achieved when it is impossible to change the allocation of resources in the economy in a way that will increase the welfare of society. The government subsidises education to address the problem of allocative inefficiency. (a) The question can be discussed with reference to the concepts of allocative inefficiency and income inequity. (b) Discuss whether a reduction in the subsidy on education is justified. (a) Explain why the government subsidises education.
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