CHAPTER 4 PUBLIC PROVISION FOR SOCIAL GOODS 49

C. MIXED GOODS
Throughout the preceding discussion, a sharp distinction was drawn between pri-
vate goods, such as hamburgers, the benefits of which are wholly internalized
(rival), and others, such as air purification, the benefits of which are wholly exter-
nal (nonrival). This polarized view is helpful for understanding the essential dif-
ference between private and social goods, but it is not realistic. In reality, mixed
situations of various kinds arise.

Externalities of Private Goods

Such is the case wherever private consumption or production activities generate
externalities.

External Benefits Suppose, for instance, that A derives benefits from being
inoculated against polio, but so do many others for whom the number of potential
carriers, and hence the danger of infection, is reduced. Or by getting educated, A
not only derives personal benefits but also makes it possible for others to enjoy
association with a more educated community. Since large numbers of other con-
sumers may be affected, bargaining does not work and a budgetary process will
again be needed to secure preference revelation. But the correct budgetary inter-
vention in this case will not involve full budgetary provision; rather, it will take the
form of subsidy to private purchases.
This is shown in Figure 4-2, where Dp represents the market demand sched-
ule, obtained by horizontal addition of demands for the private benefits which in-
dividuals derive from inoculation or from their education. Now let Dx be a supple-
mentary schedule reflecting the evaluation (or, as noted above, pseudo-demand) by
others for the external benefits generated by these activities, e.g., the reduced risk of
contagion or the pleasure of a more educated society. The D x schedule is obtained

FIGURE 4-2 Adjustment for external benefits.

Price
S'

0 Quantity
of private
purchases
50 PART 2 ALLOCATION, DISTRIBUTION, AND PUBLIC CHOICE

by vertical addition of individual demand curves for such benefits. Adding Dp and
Dx vertically, D 1 is obtained to reflect total benefits, including both the DP and Dx
components. Given this situation, the private market will result in equilibrium out-
put OQP, since only the market demand schedule DP is backed by voluntary pur-
chases. But this is inefficient since the optimal output is at Q5 , where external or
social benefits are allowed for as well.
In order to expand output from OQP to OQ5 , the government should pay a
subsidy6 equal to D x- Such a subsidy raises the market demand confronting the sup-
plier from DP to D, and output will be extended to OQ 5 • Consumers pay a net price
of OR, with the subsidy contributing the difference RT. The total cost of the sub-
sidy equals RTCF and is paid for out of the budget, financed by taxes on A and B
imposed in line with the principles that were discussed in the preceding section.
Alternatively, the subsidy may be given to the producer, lowering his net supply
schedule to S'.
All this would be simple enough if Dx and hence the required level of subsidy
were known, but such is usually not the case. Thus, the evaluation of the external
benefits-and the determination of the proper rate of subsidy-poses problems of
preference revelation similar to those which arise with social goods. Resolution
through the political process is again called for.
The polar case of social goods, examined earlier, "may thus be extended into a
band of cases involving goods in which internal benefits to the individual consumer
are increasingly supplemented by external benefits. At the one extreme of the
purely private good, the distance FC in Figure 4-2 becomes zero, as Ds is the same
as Dp and no subsidy is needed. At the other extreme of the purely social good, Ds
becomes equal to Dx and the subsidy pays the entire price, i.e., benefits are wholly
external. The good becomes a pure social good and is entirely provided for through
the budget. In between, we have the cases of mixed goods, to be financed by a mix
of private payments and of subsidies. The tax-expenditure theory of the preceding
chapter may thus be restated more generally as a tax-subsidy theory, with subsidies
ranking from 0 to 100 percent. Whereas the use of such subsidies is limited in prac-
tice, the frequent occurrence of external benefits suggests that a wider use might be
in order.

External Costs The phenomenon of benefit externalities has its counterpart

in external costs. Private consumption or production activities may generate costs
which are not ''internalized'' and not paid for by consumers or producers. As a
result, costs are imposed on society which are not accounted for, and the activity in
question tends to be overextended.
This is shown in Figure 4-3, where Dis market demand for a private good. SP
is the supply schedule, reflecting the firms' internal or private costs, with output
equal to OM and price equal to OR. An efficient solution, however, calls for in-
clusion of external costs as given by Se- To secure output at ON with price equal to
OT, the government may impose a tax on the producer equal to EO = TF, thus
raising the supply schedule to S,, reflecting both private and social cost. Equilib-

6
Rather than varying the per unit subsidy in line with Ds• the efficient outcome may also be
obtained by granting a constant unit subsidy equal to FC, thus dropping the s schedule to s'.