Public Goods

Define public goods

Non-rejectable goods not provided by the free market due to non-excludability and non-rivalry in consumption.

Define non-rejectable

Inability of consumers to refuse the consumption of a good once it has been produced.

E.g. A person living in the country is not able to refuse national defense from external threats

Define non-excludability

Once the good is provided, it becomes available for all to consume regardless of whether one has paid for it

E.g. National defense; tourists get to enjoy the same level of deterrence from foreign threats

Why does the market fail in providing non-excludable public goods?

Free rider problem; since everyone can consume the good without paying, people are unwilling to pay even though they benefit from it.

→ NO EFFECTIVE DEMAND results (hence, profit max firms unwilling to provide these goods)

Define non-rivalrous in consumption

Once the good is produced, the quality and quantity for others do not diminish with consumption.

E.g. National defense: Everyone in the country enjoys the same level of deterrence from foreign threats which does NOT diminish with a rise in birth rates (more babies being born)

Why does the market fail in providing non-rivalrous public goods?

No extra cost incurred when an additional person enjoys the benefit (i.e. security), the MSC of providing the benefit to an additional consumer (i.e. newborn babies) is 0.

• Free provision: Qs achieved when MSC = MSB, when MSB = 0 & price = 0

  • Firms unwilling to set price = 0 (undesirable), NO EFFECTIVE SUPPLY

In conjunction with no effective demand in non-excludability in public goods, there are missing market signals.

Therefore, public goods cannot be achieved under a free market → MF results

How do we correct the lack of a free market for public goods?

Government intervention — Direct Provision

→ or governments pay private firms to produce them

How does direct provision work?

• Surveys to determine market dd & MSB (free market lacks effective dd signals)

• Cost benefit analysis to determine Qs (MSC=MSB), which is amount to provide

• Socially optimal price = 0

  • non rivalrous goods → MC = 0 → Qs must be 0 → allocative efficiency achieved where P = MC → since MC = 0, P = 0

• Good is available to everyone → resolve missing market → eliminate DWL

Example of how direct provision corrects MF

Singapore: Singapore Armed Forces (SAF) is fully funded by the government under the Ministry of Defense at the socially efficient level Qs.