SOME CONCEPTS

The concepts discussed below provide essential

the question of presence and functions of a background material for the discussion ot
modern State
theoretical underpinnings for the subject matter of public which, in turn, provides necessar
finance.
PUBLIC GOoDS Vs PRIVATE GooDS
The concept of public goods was
titled "A Pure Theory of Public introduced PaulA. Samuelson in his famous contribuu
by
Expenditure". Over time, this concept has gained widespe
currency and has been refined, extended and élaborated in several ways.
A distinction
between private and public (social) goods can the basisol
presence or absence of the following two basic characteristics. be made on
The term public sector or
2. Market state sector Includes all forms of government
mechanism, in brief, represents an interaction between the (a) undertakings.
and (c) determination and
forces of suppl.
of demand, (b) forcesinteractily
variation in prices of goods
demand-flows and supply-flows of goods and services and
working of market mechanism
and services. It
generates inter-dependent and
fYomthe
3. include saving, investment, their prices. Economic activities, inseparable
Also called 'Social Goods'.
4 P.A. Samuelson, Pure production and others.
Theory
Nov. 1954, pp. 387-389. of Public xpenditure, in The Review of Economics and Vol. 36,
Statistics,
 Economic Activities and the State 3

1. Excludability
The first characteristic is that of excludability of a good. Excludability of a good means that
it is possible to restrict its availability to select users on some basis, such as, by making it a
priced good. Only those users who have the capacity and willingness to pay its price can have
it. Incontrast, a non-excludable good is either available to all or to none. A good example of a
non-excludable good is the defence of a country against foreign aggression. Once the country
is provided this protection, no section of society can be deprived of enjoying its benefits.
Defence service provided by the State cannot be priced and restricted to only those whopay
for it. Similarly, in some cases aconsumer cannot surrender the use of a service even if he
wants to. An individual cannot ask to be left undefended by the defence arrangements of the
State, or refuse the benefits of a reduction in air pollution or those of street lighting etc.
2. Rivalry
The second characteristic to be taken into account is its being rivalrous or not. When a good
is non-rivalrous, its use by some does not reduce its availability to others. In that sense, its use
cannot be rationed between its users and it is thus indivisible. There is no 'overcrowding' of
its users irrespective of their number. For example, any number of persons can tune in radio
or TV programmes without reducing their availability to others. The use of a rivalrous good,
however, reduces its availability to others.
Those goods which are both excludable and rivalrous are termed private goods or pure
private goods. Their use can be rationed between their potentialusers. In contrast, goods which
are both non-excludable and non-rivalrous are termed public goods. or social goods.
The issue of financing the provision of a specific good or service is closely linked with
it being a public good or a private good. Provision of a private good can be financed through
its sales proceeds and can, therefore, be left in the hands of the private sector. In contrast, a
public good is both non-excludable and non-rivalrous. Once it is provided, it is accessible to
all. Consequently, its provision cannot be financed through its pricing and there is a risk that
its users would not pay for itvoluntarily. For example, in the case of defence service, every
individual can argue that he would have access to it even if he does not pay for it. Its provision
for him would not be affected by his not paying for it. Consequently, very few or even none
may pay for it voluntarily hoping that the provision of the service wouldbe ensured through
the contributions and efforts of others. This phenomenon is referred to as the problem of free
riders$, that is, the non-feasibility of financing the provision of a good on avoluntary basis.
Therefore, the provision of such a good or service has to be financed through compulsory
contributions (like taxation) by the members of the society. Their financing cannot be left to
market mechanism.
It must be noted that the non-excludability of a public good does not necessarily imply that
all members share it equally. In case of a war, protection against enemy attack may, to some
extent, depend upon one's places of residence and work. Similarly, people living near political
boundaries of the country may, for obvious reasons, be comparatively less protected. People
living near public parks derive more benefit from them even when all members of society are
equally entitled to their use. Thus, the main criterion of non-excludability is that all member
5. James M. Buchanan, ThePublic Finance, Richard D. Irwin, 1970, p. 25-26.
6. lbid.
 4 Economic Activities
and the State

(or asection thereof) should be equally entitled to the use of the good in questio.
of society concerned activi.
of the
irespective of their ability or willingness to pay for it. The financing
market pricing.'
has to be through public expenditure and not through
Additional Characteristics
goods.
This leads us to look at some additional characteristics of public
Externalities
Pure public goods are characterized by the existence of externalities, that is, economic effects
which flow from their production or use etc. to third parties or economic units. Such economic
effects may also be called spill-over efects, neighborhood etfects or third-party effects. They
arise on account of interdependence of economic units via input/output relationships and may
be in fom of gains or losses. An externality may be pecuniary (that is, directly monetary)
or technological.: An externality affects the prices in the economy which in turn transmit
their effects to production and consumption decisions of other economic units. This causes
adivergence between the internal (or private) and social marginal costs (or benefits) of the
good in question. Thus, for example, pollution caused by factories, power houses, railways,
transport vehicles ete, isa cost to the society but not to the individual undertakings. Similarly,
beneficial externalities of socialõverheads like roads etc. cause adivergence between private
and social marginal benefits.
These externalities are of two types.
(i) market external (or marketable external) effects; and
(ii) non market external (or non-marketable external) effects.
In the case of non-market external effects, individual economic units cannot be identified
and compensated for loss, nor can they be identified and charged for economic gains. In
contrast, in the case of market-external effects, the losers (beneficiaries) can be identified and
compensated (charged) for the same.
By implication, provision of public goods with non market external effects should
be preferably inthe hands of the public authorities since they can provide them irrespective
of their commercial profitability. In contrast, pure public goods with market external effects
may be left in the hands of the private sector (though even here their characteristic of non
excludability demands that they should be in the hands of the public sector only).
A pure private good is supposed not to have any externalities. In its case, there is no
difference between private and social marginal costs of supply. And therefore its market price
represents its social supply cost also. By implication, even in the hands of private sector, its
supply would be at the socially optimum level. Ordinarily, therefore, the provision of pure
private goods should be entrusted to the private sector. But on account of various reasons this
may not be adhered to in every case. The government might decide to step in where merit
wants (to be discussed later in this chapter) are concerned or for other relevant considerations
like the cost conditions (discussed below), resource availability, social and political philosophy,
and so on.

7. Exclusion here will be either impossible or

inefective and also too costly.
8. Bernard P. Herber, Modern Public Finance, Richard D.
lrwin, 1967, p.27.
 Economic Activities and the State 5

Marginal Cost
Alikely characteristic of a pure public good is that its marginal cost is zero or close to zero. It
means thatan additional member of the society can he benefited by its use without appreciably
adding to its total cost. To put itdifferently, the use of apure public good by one more member
of the society does not reduce its availability to the others. Agood example of it is the tuning
in of your radio set. Stillanother example is that of a bridge, over which an additional vehicle
may pass without any additional cost tothe society. Note, however, that mostly this principle
applies, in reality, only to alimited extent. We cannot keep adding to the number of vehicles
that may use the sanme bridge: we cannot have the same defence budget if our population
keeps increasing. and so on. Also it may be added that a large part of the society may not be
able to enjoy the benefits of a publie good without adding to the cost of its supply. Similarly.
the provision of a public good may be increased or decreased for budgetary reasons or due
to some extraneous factors. Pure public goods which possess this characteristic have a strong
case for inclusion in the public sector since public goods are indivisible also. In the case of
private goods, on the other hand, the argument is basically in favour of large scale production
for which either the society should agree to a monopolistic type of private enterprise or should
goin for public sector enterprises.
Decreasing Average Cost
Another likely characteristic of a pure public good is its decreasing average cost. Being lumpy,
it would be subject to the economies of scale. If the public good is provided in small units,
then the average cost is likely to be much more. For example, the average cost of operating
a sewerage system is much smaller if it serves a wide area than when it serves only a portion
of the city. When it comes to the choice between public and private sectors for the provision
in
of goods possessing this characteristic, considerations similar to the ones mentioned above
the case of Marginal Cost characteristic apply.
Impure Public Goods
It would be noticed that it is highly difficult to come across goods which fully satisty all the
characteristics of pure public goods. Similarly, it isequally difficult tocome across pure private
privateness. The
goods. In general, most goods possess a mixture of both publicness and
goods which are
division between the two types is mostlyone of degree and not of kind. Such
public goods (also called
neither pure public goods nor pure private goods are called impure are predominant
quasipublic goods or quasi private goods). If the elements of publicness
and in the
In the mixture of characteristics of a good, then it may be termed a public good;
opposite case, a private good.
Local Public Goods
and coverage. Additional issues
Over time, the subject matter of public goods gained in depth making. Furtherimpetus
associated with their nature and relevance were identified for policy
coverage of a public good, its
Was imparted to this subject when issues like the geographical
government, determination of public
provision in acountry having two or more tiers/layers of
preferences and their aggregation for it, etc. gained prominence.
 Economic Activities and the State 7
Tiebout model is based upon some strong assumptions including the
following.
(a) Individuals possess perfect infornmation and they are free to move from
one municipal
area to the other.
(b) There are enough areas and communities to choOse from.
(c) Problems relating to migration (employment, earning, quality of
living associated with
some areas, language, culture, etc.) do not come in the way of actual
migration.
(d) Migration is costless and without any disruption.
(e) Each municipal area has a set of services which are not
revised over time.
() The quality of public services is same everywhere.
(g) Communities do not suffer from negatives like poor law and
order, or undesirable
habitants.
(h) The individuals must consume all the goods (both public and private) at the same
location, and there are no spill-over effects from one community to the other.
(i) The model ignores the availability and consumption of national level public goods.
(i)) It assumes that the extent, quality and financing of local public goods are not affected
by changing numbers of their consumers.
(k) Actual migration involves several other considerations including economic, social,
political, employment opportunities, and others.
As stated above, these are highly unrealistic assumptions. A growing economy and society,
with changing urbanization and inter-country roads, communication, rail and other facilities
and infrastructure, etc. is bound to change the scenario over time. The model does not take into
account these changes. It is set within the framework of a static economy. It loses relevance
in a country like India where every locality is not served by municipal bodies and quality and
type of services provided by municipalities widely differ from each other. In several cases,
even a large number of basic amenities are not provided. And in any case, public expenditure
in India suffers from a high degree of inefficiency. The local bodies themselves are starved of
funds and their grants etc are inadequate, and uncertain.
Consequently, *voting with the foot' is a rare phenomenon.
Ciub Goods
The concept of club goods (also termed artificially scarce goods) was introduced by James
M. Buchanan! They are a sub-set of local public goods and are characterized by an artificially
created scarcity. They are distinguished from local public goods by the fact that they are fully
excludable. They are public goods embedded with full excludability.
Potential users of club goods are not excluded on the eriterion of geographical residence,
but on the basis of some other criteria which can vary from case to case. These eriteria
normally culminate themselves in the form of club membership which, in tum, may be subject
to one or more criteria like fnancial contribution, some academic or professional qualification/
accomplishment, social status, religion, community, nationality, political views, and so on. The
list is inexhaustible.
1. James M. Buchanan, An Economic Theory of Clubs', Econometrica, Vol. 32, 8. (1965), pp. 1-14.
 8 Economic Activitiesand the State
non-rivalrous. By their very nature,
Club goods are neither fully rivalrous nor completely
up to a limit.
the number of their consumers can be increased but only
monopolies. These goods
It may be noted that suppliers of club goods are in the nature of For this
ways,
are characterized by artificial scarcity created by the suppliers in one or more
goods.
reason, club goods typically suffer from under-supply as is the case with most merit
variation. It
Over space and over time, the category of club goods is subject to a wide
also noteworthy that the precise nature of club goods is shrouded in a blanket of haziness
and in some cases, it may be difficult to decide when a specified good becomes a club good
and when it ceases to be so. In India, for example, we have roads built and operated on the
basis of public-private partnership. The users of such roads are categorized on the basis of
certain criteria and some categories of users have to pay the toll. That way, these roads have
a diferentiated excludability as in the case of club goods. But a toll road becomes rivalrous
only when it is crowded beyond a limit. So long as it is partially rivalrous, it is a club good.
But once it is crowded beyond a limit and becomes fully rivalrous, it assumes the nature of a
private good (which is both excludable and rivalrous).
Observation on Free Ridership. It is pertinent to note that the problem of free ridership
can exist only when a good is fully non-excludable, irrespective of whether it is also
rivalrous
non-rivalrous. Local public goods and club goods are, by their very nature, impure public
goods. Assumptions made in Tiebout model and club theory are such that
by local authorities and clubs become fully excludable. For goods provided
this reason, the problem of free
ridership ceases to exist in their case.