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IAI Actuarial Core Principles · Business Economics · Government intervention in a market

A vaccine costs Rs 400 per dose privately. Each dose gives the individual a private benefit worth Rs 500 at the margin of consumption in a given range, but also gives uninfected others a benefit of Rs 300 per dose. Individuals buy while private benefit exceeds price. Which statement is correct about intervention to reach the social optimum?

The external benefit of Rs 300 per dose is not captured by buyers, so marginal social benefit exceeds marginal private benefit by that amount. The market underconsumes the vaccine, and a subsidy of up to Rs 300 per dose could correct this positive externality.

  1. AMarginal social benefit exceeds marginal private benefit by Rs 300, so a subsidy of up to Rs 300 per dose could correct underconsumptionCorrect
  2. BThe vaccine is overconsumed, so a Rs 300 tax is appropriate
  3. CMarginal social benefit is Rs 200, so no intervention is needed
  4. DMarginal social benefit is Rs 800, so the optimal subsidy is Rs 800
  5. Because private benefit exceeds price, there is no market failure

Explanation

MSB = 500 + 300 = Rs 800 against price Rs 400. Individuals stop buying where private benefit falls to Rs 400, ignoring the external Rs 300 benefit. The gap of Rs 300 between social and private benefit is the positive externality, so a subsidy equal to it moves consumption to the optimum. Rs 800 is the total social benefit, not the subsidy.

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