What is a positive externality?

A positive externality can be seen when the consumption or production of a good causes benefits to a third party.
Here we are interested in positive production externalities specifically which means that the marginal private cost is higher than the social marginal cost.  Examples include infrastructure projects such as the building of a new airport, the private cost to the operator of providing the airport reduces societal costs as it may now be cheaper to import raw materials or the extra flights may lower the price of holidays.

Diagram showing the positive externalities in production

The diagram shows that there is an underproduction of the good or service.  The free market equilibrium P1Q1 shows a lower quantity than the social optimum equilibrium of P2Q2. The yellow triangle show the dead weight loss in the market when output is at Q2.

The market is currently failing as there is an inefficient allocation of resources.  Society values the production of this good at Q2 but high costs cause an under-provision. These markets are usually markets that provide merit goods such as green spaces, gyms or education.

To boost the supply and increase the overall quantity traded the government must intervene.  Interventions to lower the cost of production are likely to be successful as it provides firms incentives to increase supply.