Unit 2.

9: Public goods
What you should know by the end of this chapter:

• The nature of public goods

• Concepts of non-rivalrous and non-excludable
consumption
• Free rider problem leading to market failure
• Policy approach to the market failure associated
with public goods
• State provision of public goods
• Alternative methods of provision by the private
sector

What is a public good?

Public goods or pure public goods are goods that bring significant social benefits to society but
cannot be provided by the free market. They are a market failure, which means the government
needs to intervene in the market to ensure they are provided. Because they bring significant social
benefits we also consider them to be merit goods.

Public goods have two characteristics:

Non-rivalrous

Non-rivalrous means the consumption by one individual does not reduce the availability to others.
For example, if a group of people are benefiting from a public good like street-lighting and an extra
person comes along to take advantage of the light the availability to the existing consumers is not
reduced. This means the marginal cost (the cost of providing the good to an additional consumer) of
providing a public good is zero once it is set up and being produced. The extra person who benefits
from street-lighting adds nothing to the cost of providing the streetlight.

Non-excludable

Once a public good is being produced it is impossible to stop people from benefiting from it. Once
streetlights are turned on it is impossible to stop people from benefiting from them, assuming they
can get to an area covered by the lights.

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InThinking www.thinkib.net/Economics 1
Examples of pure public goods
There are not many examples of pure public goods, but economic theory
would normally include flood barriers, sea defences, street lighting and
national defence.

Economists often distinguish between pure public goods and quasi-public

goods. Quasi-public goods have some elements of being non-rivalrous and
non-excludable but not in the precise way that defines pure public goods.

Examples include roads, bridges and public parks. Roads have some of the characteristics of public
goods, but the space on a road can be looked at as being rivalrous when too many cars use them,
and they can be excludable if tolls are in place.

Public goods as a market failure

Public goods are considered an example of market failure in pure free markets because they would
not be produced. This is because of the ‘free rider’ problem. Once a public good is set up and being
produced it is impossible to prevent people from benefiting from it (non-excludability) even if they
have not paid for the good: some individuals free ride 'on the back' of the consumption paid for by
others.

Consider the example of a town that keeps being flooded by a river. The town needs a flood
defence. A group of people who live alongside the river think of pooling their money to pay for flood
defences, but they do not have enough money to pay for the barrier unless the whole town
contributes.

Large numbers of people in the town choose not to contribute as they know that once the flood
barrier is built they can benefit from it without paying – they can free ride on the consumption of
those who do pay. This means the market price of the flood barrier will not be high enough for it to
be provided. Public goods like flood barriers often have very high initial set-up costs so even wealthy
philanthropic individuals would not be able to fund their provision.

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InThinking www.thinkib.net/Economics 2
Diagram 2.53 shows how the socially
efficient output of the blood barrier at Q*
where MSB equals MSC. The MSC curve
in this case is horizontal at C because the
marginal cost of an additional user of a
flood barrier is zero. Once the flood
barrier is set up the marginal cost of
providing it to each additional consumer
does not change as more consumers
benefit from it.

If the flood barrier costs $1Bn the cost will not change if two million people benefit from it or three
million people benefit from it. Remember, this is hypothetical because in a free market the flood
barrier would not be built. Because the output is zero in the market the whole yellow shaded area is
the welfare loss.

Government intervention to manage public goods

The nature of pure public goods means that they will not be provided by the free market. Where a
public good is something society should provide (street-lighting, defence and flood defences) the
government can intervene through direct state provision. Quasi-public goods like parks, the police
and street cleaning will be under-provided in a free market and governments intervene to produce
quasi-public goods at the socially efficient level of output.

State provision
Where governments see the provision of a public good as crucial to society they will set up and
provide the public good. Most countries have public goods that are set up and provided by the
state. Public goods such as national defence, flood defences and street lighting are directly provided
by the government and funded through taxation.

Advantages of state provision:

• Government provision of public goods is the only way they can be produced. Remember the
free market will not generate a price that can support the production of a public good.

• Government are more likely to provide quasi-public goods near the socially efficient output.

• When the government is providing a public good it is more likely to make decisions in the
public interest compared to private sector businesses that aim to make a profit. This could
be important in the provision of quasi-public goods such as parks.

• Governments can provide public goods at zero price so they are available to low-income
households.

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InThinking www.thinkib.net/Economics 3
Disadvantages of state provision:

• The cost of providing state-funded and managed public goods is extremely high and there is
a significant opportunity cost to the government in terms of other areas of expenditure.

• Some people question the efficiency of state-run organisations that provide public goods.

• State-managed and organised public goods can be influenced by political decision making
which may not be in the best interests of society. For example, expenditure on defence can
be influenced by political rather than welfare factors.

• It is impossible to accurately know the level of provision of the public good that is socially
efficient.

Private sector operation

Governments can set up and pay for the provision of public
goods that can then be managed by private sector
organisations. This is particularly the case with quasi-public
goods like street cleaning. In this situation, the government
pays private businesses that are contracted to clean the streets
and dispose of waste.

Advantages of private sector provision:

• This approach has the benefit of making sure the public good is provided, but the
operational management may be more efficient than government-managed provision.

• Private sector provision means political decision-making is less likely to take place in the
management of the public good.

The problems with this approach:

• The cost of setting up the provision of the public good still needs to be paid for by the
government which will come with an opportunity cost.

• A private sector firm may provide the service putting profit ahead of welfare. Private sector-
operated prisons are sometimes criticised for cost-cutting management practices.

• It is impossible to know the level of provision of a private sector-managed public good to

achieve the socially efficient output.

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InThinking www.thinkib.net/Economics 4