In this essay I will analyze the case of public goods, one of
the main causes of market failure. Market failure is a situation of economic
inefficiency, a situation in which the market is not Pareto-efficient. In other
words, it is a case in which there are some welfare losses.
I will firstly outline two main characteristics that help
economists to identify public goods and distinguish between them: non-rivalness
and non excludability. Based on these two features, scholars have identified
different types of goods that in some cases may bring the market to a failure.
Once highlighted their characteristics, I will then present the welfare losses
and conclude by showing the ways in which governments can intervene to solve
When public goods have to be defined, economists often use
their non-rivalness feature to describe them. This means that “If a public
good is available to one person it can be available to everyone else at no
additional cost” (Bowles, S., Carlin, W. and Stevens, M. (2017)). Goods of this
kind are thus called public goods. For instance, lighthouses, clean air or
national defence are goods whose marginal cost of making it available to
another person is zero. Once the street is lighted, it does not matter how many
people live there or simply benefit from it. The same can be said for clean air
or national defence. These services are not paid for individually (like it
would happen for the purchase of a grocery good), but are available to the
entire community, i.e. they are non-rival.
Other economists also call public goods the non-excludable
ones. This mean that, “once available for one person, other cannot be excluded
from its use” (Bowles, S., Carlin, W. and Stevens, M. (2017)). An example of
this feature are forests, or what in general is called as a common pool
resource. However, nowadays, most
economists agree that pure public goods are goods that are both non-rival and
Originally, the concept of public good only relied on its
non-rivalness feature, but according to a broader point of view, which includes
in the definition the non-excludability as well, there are three different
types of public goods: those which are non-excludable but rival (common goods),
those non-rival but excludable (artificially scarce goods) and the so-called
pure public goods, goods that are both non-rival and non-excludable.
The fact that some public goods are non-excludable is often a
problem. People can in fact benefit from it without paying for the good for the
simple reason that they cannot be excluded. This problem is called The free-riders problem, and it is one
case of market failure, a situation of economic inefficiency. The provider has
in fact no way of charging a price for a good that is non-excludable. This is
not only the situation for pure public goods, such as clean air, or more
generally collective goods, but also the case of common goods, common pool resources, (fisheries,
mines, forests etc.).
As perfectly demonstrated by Anthony Downs (1957), people
have an incentive to free-ride: “Provision of national defence is a boon to
every citizen; even if one citizen paid for it solely out of his own pocket,
all the others would gain from it. Where citizens are numerous, each man finds
it advantageous to refuse to pay for such indivisible benefits. Instead he
assumes that other men will bear the cost and he will benefit… This situation
means that voluntary action cannot produce a Paerian optimum in a large society
when collective goods exit.”
Another problem of public good is related to its
non-rivalness feature and therefore concerns pure public goods and artificially
scarce goods. As noted by Samuelson (1954),
non-rival goods’ marginal cost is equal to zero. “In standard price
theory, in which price tends to equate to marginal cost, such goods should have
a zero price. But if they are priced at zero, they will generally not be
provided.” (Hardin, 2013)
Public policy has thus to face two problems about public
goods: on the one hand the question of regulating free-riding and on the other
hand the fact that non-rival goods might not be provided. In other words,
policy-makers have to control over-consumption and under-production.
Governments are the main agent addressed by societies to
regulate free-riding. Policy makers can in fact intervene in different ways to
correct the market failure and make it Pareto-efficient. The most common way of
intervening is without doubt taxation. Governments impose general taxes to
constrain people to pay for the services they might use. People are so forced
to contribute to any public good which they may benefit from.
Another way is soliciting donations. This mechanism usually
only works for low-cost services, such as the maintenance of museums or
gardens. People are so asked to make and donation for the service they have
enjoyed. Even though very few pay, they will cover the entire expenses and
there is no need to turn to compulsory payments.
Governments can also decide to privatise public goods to
solve the market-failure. However, this solution is only valid for some cases.
For instance, companies can use tolls to make people pay for highways, but can
they do the same for sidewalks? Conversely, some public goods, such as
knowledge, can be privatized by issuing patents to protect and stimulate research.
When governments have to provide public goods, they also face
another problem: understanding the optimal quantity to provide, i.e. they have
to determine the socially efficient level. In order to do this, policy-makers
have to consider all the personal demand curves and sum them up to get the
collective demand curve. Once the social level established, it has to be equal
to marginal cost. That point is indeed the socially efficient level.
The other problem that policy makers have to address is the fact
that the market may not provide non-rival goods. In fact, as abovementioned, in
any transaction that is Pareto-efficient, the price has to be equal to the
marginal cost. With this type of good, the marginal cost is zero and thus the
only way to let the market provide is to subsidize providers.
As it has been shown, there are only a few ways of solving
market failures caused by public goods. They are all connected to governments
actions and in some cases very limited. Public goods are a social possessions,
to avoid over-exploitation or to guarantee provision those measures are
strictly necessary not only to prevent welfare losses, but also to make sure
that every community can benefit from what belongs to it.