Chap 3: Public Goods

Definition to use when starting questions relating to public goods

Public goods are goods or services that have the characteristics of non-excludability and non-rivalry in consumption. Such goods cannot be provided by the market, and it is a case where the free market fails to allocate any resources to produce goods that could enhance the welfare of society.

Definition for non-excludability

Non-excludable in consumption refers to the situation where the consumption or use of the good or service cannot be limited to the consumers who have paid for it. This is due to the lack of private property rights over its use because it is impossible or prohibitively expensive to exclude non-payers from consuming it

Example + elab of a non-excludable good.

Street lighting. Once it is provided, there is no inexpensive or practical way to restrict the availability of the service to only people who pay for their use.

Definition for non-rivalry

Non-rivalry in consumption refers to the situation where the consumption or use of the good or service by one consumer does not reduce its availability to another consumer.

Example + elab of a non-rival good.

Street lighting. The use of street lighting by one pedestrian will not reduce the amount of light available to others. The benefit of street lighting can be shared jointly by everyone who happens to be in the vicinity of the street lights.

Definition for non-rejectability

Non-rejectability is defined as the inability of consumers to refuse the consumption of a good once it has been produced

Example + elab of a non-rejectable good.

Street lighting. Once it is provided, an individual walking along the brightened street cannot reject the light that is provided

What are the consequences of the characteristics of public goods?

Free ridership, no price signals, no user charge

Explain how free ridership works + its effects

As a result of the characteristics of non-excludability, once a public good is provided, others can free ride on the good. A free rider is anyone who receives the benefits of a good or service without having to pay for it. Since anyone can enjoy all the benefits of a public good once it is produced without paying for it, no rational consumer motivated by self interest will reveal his effective demand.

Explain how no price signals works + its effects

There will be no price signals to indicate consumers’ preference for such goods. Hence producers will not supply the good, despite the fact that public goods such as street lighting yield valuable benefits to society.

Explain how no user charge works + its effects

As a result of non-rivalry, the marginal cost of providing a public good to an additional consumer is 0. Since the optimal quantity to supply is where Price = Marginal Cost, the efficient price to charge for the use of public goods is 0. However, this means that no private firm in a free market can supply it profitably. Hence, the market fails to allocate resources to produce such goods.

Why is the market unable to allocate resources to produce public goods + why is there market failure?

This is as it is neither possible (due to non-excludability in consumption) nor desirable (due to non-rivalry in consumption) for private producers to charge a price for its use. Without the profit incentive and price signals, the market is unable to allocate resources for production, leading to complete market failure in the provision of public goods.

What is the solution for public goods?

Direct provision by government

Explain why direct provision by government can be used to solve the issue arising from public goods (theory)

Due to the problem arising from the non-rivalry and non-excludability characteristics of public goods, no free markets will provide them and hence the government has to provide public goods in order to enhance society's welfare. The government is in the best position to provide public goods since their objective is not to maximise profits, unlike that of the private producers.

Explain why direct provision by government can be used to solve the issue arising from public goods (how its carried out)

In their pursuit to maximise social welfare, the government will take into account the full social costs and benefits generated by public goods. The government can choose to produce the goods or services themselves or they can outsource to a private company to do it but bear the full cost.

What are the limitations of direct provision by government as a solution?

Lack of information, lack of public funds, political pressures

Explain why lack of information is a limitation for the solution of direct provision by government.

While it is clear that only the government can provide public goods, there is no guarantee that government provision will lead to efficient allocation. The lack of price signals makes it difficult to determine the optimal level of provision as those who want the goods are not prepared to reveal their true preference via the price mechanism. Thus from the standpoint of efficiency society's welfare will not be maximised if too much or too little of the good is produced.

Explain why lack of public funds is a limitation for the solution of direct provision by government.

The provision of public goods is funded by taxation. As such, it is not always possible to provide sufficient public goods if there is not enough tax revenue, ie the provision of public goods is constrained by the state of the government finances, such as during a recession

Explain why political pressures is a limitation for the solution of direct provision by government.

Governments may make decisions based on political popularity, and decisions may be affected by the pursuit of self-interests among politicians rather than the pursuit of the socially optimal outcome, leading to a misallocation of resources. Electoral pressures may also lead to inappropriate government spending and tax decisions.