Public Goods

PUBLIC GOODS
Public goods are materials, products or services that anyone in a given society can access.
Government agencies typically provide and distribute public goods. Whether or not they use the
public good themselves, people within that region or nation collectively pay for the public goods
they have access to through their society's tax system. For example, security, education and
knowledge, environment, infrastructure, public health, public parks, streetlights etc.
Economists categorize a good as a public good if it is both non-excludable and non-rivalrous.

Non-excludable means all individuals and groups of people within that society have access to
the items or services. If Larry buys a private good like a piece of pizza, then he can exclude
others, like Lorna, from eating that pizza. However, if national defense is being provided, then it
includes everyone. Even if you strongly disagree with America’s defense policies or with the
level of defense spending, the national defense still protects you. You cannot choose to be
unprotected, and national defense cannot protect everyone else and exclude you.
Non-rivalrous refers to how the use of the item or service does not lead to a shortage of that
good for others. With public goods, all members of a society can access these materials or
services without leading to a significant reduction in those public goods. With a private good like
pizza, if Max is eating the pizza then Michelle cannot also eat it; that is, the two people are rivals
in consumption. With a public good like national defense, Max’s consumption of national
defense does not reduce the amount left for Michelle, so they are nonrivalrous in this area.
Distinguishing if a particular resource appears as both non-rivalrous and non-excludable can

sometimes become challenging for economists and other professionals. For example, although
most professionals consider street lighting to be a public good, the individuals who use
streetlights can sometimes affect the functionality of streetlights in their area. This could then
affect the effectiveness of street lighting in that region or cause government bodies to restrict
public access to streetlights. Another potential complication to how public goods work is known
casually as the free-rider problem. This refers to how some members of a society may avoid
paying for the public good through taxes, even though those individuals still have unlimited
access to that good.
Private good
Private good is one whose consumption by one individual would reduce its supply for others. For
given amount of good if consume more of it by A then less is left for B, e.g., if more bread is
consume by A from the given, then less would be available for B. Similarly if more steel is
consumed by present generation, then less would remain for the future generation.
The Free Rider Problem of Public Goods
Private companies find it difficult to produce public goods. If a good or service is non
excludable, like national defense, so that it is impossible or very costly to exclude people from
using this good or service, then how can a firm charge people for it?
When individuals make decisions about buying a public good, a free rider problem can arise, in
which people have an incentive to let others pay for the public good and then to “free ride” on
the purchases of others. The problem states that because people cannot be excluded from
consuming public goods, there is incentive for persons in these situations to free ride and tries to
enjoy benefits from those public goods without paying from them. Due to free – rider’s problem
the producer of public commodity will either not produce it pr produce too little of it creating
economic inefficiency of Pareto non – optimality.
The free rider problem can be overcome through measures to assure that users of the public good
pay for it. Such measures include government actions, social pressures, and specific situations
where markets have discovered a way to collect payments.
Public Goods and Market Failure

Generally perfectly competitive market ensures Pareto optimality or economic efficiency. Under
some circumstances the market system cannot lead to this optimum situation of Pareto efficiency
i.e. state of maximum social welfare. This situation where market fails to achieve economic
efficiency is being called as market failure. Main causes of market failure:
 Existence of monopoly or imperfect competition  Presence of externalities  Consumption of

public goods
The existence of public goods can cause market failure because they are not efficiently allocated
through the market mechanism of supply and demand. Because public goods are non-excludable,
there is no way for private firms to charge consumers for their use. As a result, private firms may
be unwilling to invest in the production of public goods because they cannot capture the full
value of their investment.
Furthermore, because public goods are non-rivalrous, consumers may be unwilling to pay the
full cost of their production, as they can free-ride on the consumption of others. This can result in
under-provision of public goods, as private firms may not invest in their production, and
consumers may not be willing to pay for them at a level that would make their provision
economically viable.
Thus, the existence of pure public goods can cause market failure by leading to under-provision
of goods that are socially desirable but not profitable for private firms to produce, resulting in a
suboptimal allocation of resources
Condition of market failure
The occurrence of free-rider problem results in less than socially optimal production of public
goods. To understand how public goods causes market failure let us consider the following
graph. Let us consider a society consisting of two individuals A and B only and the public good
offered is pollution control project. The valuation of this pollution control project is valued
differently by these two consumers. The figure below depicts marginal benefits obtained by the
two consumers from the supply of this particular public commodity. In other words this curve
shows the price which the individuals are willing to pay for the different quantities of pollution
free air. MBA denotes marginal benefits obtained by individual A and MBB denotes the marginal
benefits obtained by individual B. Since the two consumers value this public commodity
differently, consumer A is willing to pay Q1A1 for OQ1 quantity of pollution-free air and
individual B is willing to pay Q1B1 for same OQ1 quantity of pollution-free air. Further, market
demand curve is derived by summing up vertically the demand curves of the individual
consumers because each individual consumes the same units of the good at the same time.
OH curve shows the marginal cost of production of pollution-free air. In this case MC is taken to
be constant. E is the point of equilibrium where the market demand curve denoted by D
intersects the marginal cost curve MC denoted by OH. Thus it is observed that aggregate
marginal benefit curve and marginal cost of production are equal at OQ level of output of
pollution-free air. Here OQ is Pareto-efficient level of output of the public good. A private firm
will produce Pareto optimum output OQ only if each individual pays a price equal to the
marginal benefit. At this level of output price paid by A is QA3 and that by B QB3. If both
individuals pay price equal to their marginal benefits then together they will pay for
Paretoefficient quantity OQ. But due to inability of the producer of a public good to exclude
those who do not pay and want to be free-riders, the cost of optimal level of output cannot be
covered by private producer. Thus private production and functioning of market in case of public
good do not lead to Pareto-efficiency in the provision of public goods and thus market failure
emerges.

Public Goods

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PUBLIC GOODS

Economists categorize a good as a public good if it is both non-excludable and non-rivalrous.

Distinguishing if a particular resource appears as both non-rivalrous and non-excludable can

The Free Rider Problem of Public Goods

Public Goods and Market Failure

 Existence of monopoly or imperfect competition  Presence of externalities  Consumption of

Condition of market failure

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