My concern in this essay is to describe public goods as a
source of market failure and to explain why markets generally fail to allocate
The Sloman Economic Book defines public goods as “a category of goods where the
positive externalities are so great that the free market, whether perfect or
imperfect, may not produce at all”. It also defines public goods by to
important characteristics: non-rivalry and non-excludability.
A public good is non-rivalrous when it benefits all individuals, in the sense
that once the good is provided, everyone can enjoy its benefits without
limiting the benefits enjoyed by others. In other words, non-rivalry refers to
the inefficiency to exclude someone from using a public good, when the cost of
serving an additional person is equal to zero.
It can also be non-excludable, meaning that is practically impossible to
prevent someone from using the good and charge them for the costs of producing
it. If I buy, for instance, a slice of pizza (private good) by purchasing it I
gain the right to exclude others from having the same slice of pizza, but if we
consider a public service e.g. national defence (which is both non-rivalrous
and non-excludable) then there’s no feasible way to exclude someone from receiving
the benefits of national defence protection (Tutor2u).
Generally, pure public goods are defined by both the non-rivalry and non-excludability
traits, whereas public goods, like a satellite TV or a copyrighted book, are
mainly characterised by non-rivalry (The Core Project, p. 523).
Public goods for which it is possible to exclude others are called club goods
and goods that are rival in consumption, but not excludable are referred as
common-pool resources e.g. fisheries (The Core Project, p. 524).
The key issue that highly affects the efficient provision of public goods in
the markets is referred as “the free rider problem”, which occurs due to the
non- excludability characteristic of public goods. This happens because when a
good is available to all, some people will be tempted to free ride and enjoy
the benefits without actually having to contribute to it, therefore if everyone
is able to free ride then there would be no incentive left to produce it
through the market.
One method businesses can use to solve the free riding problem is developing mechanisms
to exclude non-payers from enjoying a specific service e.g. TV broadcast or
digital music, but clearly the same approach cannot be made with every single public
good (J. Anomaly. p. 110)
Since individuals cannot be charged for the use of
collective goods, private firms do not find it profitable to produce and supply
them. If people cannot be prevented from consuming public goods, it becomes
infeasible to sell them the same way as private goods.
For the reasons stated above, the government intervention
is most of the time required to supply public goods. Even the classic economist Adam Smith argued in
his Wealth of Nations that one of the
three main government duties is to provide for those goods of which benefits
can be extended to the collectiveness, or more precisely, he stated:
“The third and last duty of the sovereign or commonwealth, is that of
erecting and maintaining those public institutions and those public works,
which though they may be in the highest degree advantageous to a great society,
are, however, of such a nature, that the profit could never repay the expense
to any individual, or small number of individuals; and which it, therefore,
cannot be expected that any individual, or small number of individuals, should
erect or maintain. The performance of this duty requires, too, very different
degrees of expense in the different periods of society”. ((1776: Bk 5, chapter
Public goods do not necessarily need government’s provision; some of them can
be supplied privately, through charity for instance and others are just naturally
available e.g. beaches, rivers, clear air, etc. However, public goods are
crucial for the well-being of the society and they satisfy important collective
needs, therefore government must come into play if it wants to ensure the correct
development and stability of its economy.
Having established the need of government action to provide for public goods
when the private sector fails to do so, I shall move on to the ways and means
it can use intervene to address the market failure.
Before attempting to supply
for a public project policy makers should investigate the demand for the goods
which are actually required and demanded by citizens as well as performing a
cost-benefit analysis to compare the total benefits with the total costs of
providing the goods in question (Estrin et al, p.498).
According to the standard cost-benefit logic, government should increase production
until marginal benefits equal marginal costs, if the marginal benefits exceed
the marginal costs of producing the next unit, then it should be provided.
After that it can calculate the market demand for the public good by summing vertically
the individual demand curves to measure the amount of money consumers are
willing to pay for each unit of the public good (Acemoglu et al, pg. 218-219).
The question is: how can the government
find all the information regarding people preferences and WTP to derive the
market demand curve for a public good?
One problem that concerns the government when dealing with a public good is
establishing the actual demand for it, because the issue, in fact, arises in
the demand side of the market for these goods, but how can it find all the
information regarding people preferences and WTP to derive the market demand
curve for a public good?
Contingent evaluation surveys can help obtain information to measure demand of
non- marketed goods by asking people about their willingness to pay for the
provision of a specific public project. CV surveys are usually used for problems
concerning the environment, but unfortunately they do not always take account
of different variables such as the people’s ability to pay or their budget
constraints as well as how much they want and they are informed about the good
in question. Overall these different variables make CV surveys flawed tool for
gauging demand for public goods (J. Anomaly. p. 113-114).
Voting is another method used to assess the demand for a public good and
determine society’s preferences for a particular policy but like CV, this tool
is not infallible because some voters may vote strategically or not vote at
all, thus not reveal their true preferences (Batina & Ihori, p.54-73).
Eventually the government will find the information needed to calculate demand
and the mean to raise funds to produce a public good.
The benefits of public goods provide an argument for imposed taxation since
people can be made better off by requesting them to do something that will
unlikely do voluntary. This method can help overcome the free rider problem, but
taxation means also that some people will be turned into “forced riders”,
because they will still contribute to the public good even though the benefits
arising form it are low (Cowen, Tabarrok, pg. 356)
Government can also help enforce contracts and resolve disputes for local
public goods that are not consumed by many people and facilitate their
provision by altering property rights or reducing transaction costs i.e. costs
of bargaining (J. Anomaly. pg. 120).
In conclusion, providing for most of public goods, which are indeed essential
for a fully functioning society, can be a hard task not only for the markets
but for governments as well,
Nevertheless, after reviewing the problem associated with public goods’
provision, I now understand, although superficially, the reason for the market
failure, thus for the need of state intervention.
WORD COUNT: 1,280
– Acemoglu, Laibson, List: Microeconomics, 2nd Edition (2018), Chapter
9: Externalities and Public Goods pp. 218-219
– Anomaly. J.: Public Goods and Government Action (2015), Why public
goods matter p.110, Gauging demand p.113-114.
– Batina, Ihori: Public Goods Theories and Evidence (2005), Determining
Demand for Public Goods: Voting and Mechanisms pp.54-77.
– Cowen, Tabarrok: Modern Principles: Macroeconomics, 3rd
Edition (2014), Public Goods and the Tragedy of the Commons pp.356.
– Estrin, Laidler, Dietrich: Microeconomics 5th Edition (2008), Taxes,
Externalities and Public Goods p.498.
– Sloman, Wride: Economics 7th Edition (2009), The Case for
Government Intervention p.315.
– Smith: The Wealth of Nations (1776), Book 5, Chapter 1.
– The Core Team: The Economy (2017), Markets, Efficiency, And Public Policy,
Unit 12 pp. 523-524.