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Public Goods

Public Goods

04/22/2021
Public Goods and Market failure
Edubomb Edubomb

Public Goods and Market Failures

Public goods ‘is a technical term that has a narrower meaning than the ‘public interest and is defined by the characteristics of services that private providers are likely to undersupply because they cannot recover their full costs. Public goods have two distinctive features:

• Once a public good is provided, it is difficult to exclude non-payers from receiving the related benefits because there is a ‘free rider’ problem. This is known as non-excludable consumption.

• Once a public good is provided, one person’s use of it does not limit its availability for use by others. This is known as non-rival consumption.

 

 For example, firework display, a firework display is shown in the outside or public place, and everyone enjoys it. No one can exclude it and the use of it by one person doesn’t reduce the amount for another person. Hence there are no rivals in consumption. Similarly, street light, you cannot exclude the use of street light or you cannot say that I don’t use it. Similarly, it has no rivals in consumption it means use by one person does not reduce the amount for the other person.

Concept of the public good is related to the demand side market failure. When consumers don’t pay the cost of consumption of goods and services then the firm cannot produce because the firm cannot cover the cost of production. For example, during a firework display, they are displayed in the public area or outside, everyone can enjoy it without paying. If everyone can enjoy it without paying it, then no one pays for it to enjoy. It means the private sector does not produce such public goods due to which there may be a shortage of such goods and services in the market. Suppose if they produce then still there will be price discrimination in between those who are paying and enjoying it and anyone who is not paying but enjoying it.   It means the production of such goods and service is less than the optimal level of production as well as there is price discrimination for different buyers. Hence it can cause market failure.

 As we have discussed above public goods consist of two key charter non-excludable and non-rivals in consumption. In general, its benefits can be distributed without any additional cost. If such zero-cost goods are priced higher than the marginal cost then, it can cause market failure.  For maximum social welfare, the social marginal cost of public goods must be equal to the social marginal benefit. If the condition is not fulfilled then Pareto optimality cannot be attained. Free rider the problem in the public goods can cause the market failure. Let us take one example that there is a mosquitoes abatement program in a community worth 1 million. It means the social cost is worth one million. Let There are two individuals A and B in the community. Since mosquito abatement is public goods no one can exclude it. Here both individuals are getting equal benefits but one is not willing to pay the full cost I.e. 0.5 million. If total social marginal cost I.e. one million is not equal to social marginal benefit then Pareto optimality cannot be attained.

Let Da be the demand for A and Db be the demand for B, similarly OPa be the price paid by A and OPb be the price paid by B which are shown in the figure. Here summation of the demand of each individual A and B is equal to the total demand in the community.

Here, total marginal cost I.e. one million should be equal to the price paid by the two individual A and B.

 But price paid by B is not equal to A is less than the actual amount to be paid hence, there is price discrimination between the two individual A and B. Such price discrimination can cause market failure. 

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