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AS Economics

Public Goods and Market Failure

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AS EconomicsPowerPoint Briefings 2006PowerPoint Briefings 2006

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Introduction

• Businesses in the private sector of the economy may not provide public goods –leading to market failure

• It is important to distinguish between private and public goods

• And to understand why the market may not offer public goods!

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Characteristics of Private Goods

• What are private goods?

• Private goods are excludable– Consumers of private goods can be

excluded from consuming the product if they are not willing or able to pay for it

– For example - a ticket to the theatre or a sports event or a meal in a restaurant

– If you don’t pay – you don’t consume and benefit from the good or service!

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Private Goods

• Private goods are rival– One person's consumption reduces the

amount left for others to consume

– Scarce resources are used up in producing and supplying the good or service

– There is an opportunity cost

• Private goods are rejectable– Private goods can be rejected

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Private Goods

Private goods and service are rival and excludable

The private sector can supply private goods because they can charge consumers and make a profit

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Digital “pay per view” – an excludable private good – a growing market too!

Sporting events

Movies

Internetservices

News

Repeat TV

Onlinelibraries

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What are Public Goods?

• Pure public goods have three main characteristics:

• Non-excludability: – The benefits of public goods cannot be

confined to those who have paid for it

– Non-payers can enjoy the benefits of consumption at no financial cost to them

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Public Goods

• Non-rivalry in consumption: – Consumption of a public good by one

person does not reduce the availability of a good to others

– In other words, if the good is provided for one person it must be provided for others

• Non-rejectable– If a public good is provided, we cannot

avoid it

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Public Goods?

The benefits of water filtration systems, the enjoyment from a fireworks display, the light for passing ships from a lighthouse – are these examples of pure public goods?

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Goods and services – public or private?

• The Forth Road Bridge• Mass MMR vaccination programme• The Fire Service• The Police Service• National nuclear defence system• Analogue broadcasting services• Pay per view television provided by Sky TV• Street lighting• Air waves / radio spectrums• The M25 motorway on a quiet Sunday morning• The M6 Toll Road• Ticket to Chelsea v Barcelona in the Champion’s League• A large scale fireworks display in a local town

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Pure Public Goods

• Pure public goods are also known as collective consumption goods

• National Defence Systems

• Sewage and Waste Disposal Systems

• Lighthouse Protection

• National Rail Safety Systems

• Street Lighting

• Firework Displays

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Semi-Public (Quasi) Public Goods

• These are products that are public in nature, but do not exhibit fully the features of non-excludability and non-rivalry

• They may become non-rival e.g. at peak times when congestion occurs

• On grounds of equity the government may provide these goods directly and finance them through general taxation

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Semi-Public (Quasi) Public Goods– There is an element of excludability or rivalry in

consumption

– Examples might include:

• Motorways and major roads

• Parks

• Terrestrial television (public service broadcasting)

• Police Force protection

• Galleries and Museums

• Airwaves

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Are beaches pure public goods?

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What about the air waves?

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Auction of mobile phone licences

• In 2000 the UK government auctioned off five licences for 3rd generation mobile phones

• In total, telecoms companies bid £22 billion!

• They are now saddled with huge debts

• Did the government have the right to sell off what people perceive to be a public good?

• Or are air waves a commodity like everything else?

• An example of the “winner’s curse”?

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Why does the state provide public goods?

• On grounds of equity – so that people on all levels of income can have access to them– Provision on grounds of need rather than

ability to pay

• On grounds of efficiency– Easier to provide them collectively– Economies of scale from providing to all?

• To overcome the free-rider problem• To correct for market failure – the failure of

the market to provide sufficient public goods

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The Free Rider Problem

• Markets work best when goods and services are private – they are rival and excludable

• Consumers have an incentive to not reveal their willingness and ability to pay for public goods if they believe that they will be expected or required to contribute to financing the public good

• Good examples to use include TV Licence dodgers and people who choose to evade Council Tax but who still receive local authority services

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The Free Rider Problem

• Another example might be a group of residents in a block of flats who all stand to benefit from better lighting and security systems, but who individually might try to avoid payment and benefit once the improved amenities are in place

• Given the nature of the free rider problem, public goods are often financed through some form of enforcement, notably the compulsory nature of the TV Licence fee

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Paying for public goods

• Markets cannot provide the incentives needed to supply essential services such as policing and defence causing allocative inefficiency.

• Hence public goods are provided collectively by government and financed through general taxation or other forms of charge e.g.. The BBC licence fee.

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Public bads

• Environmental damage and global warming affects everyone – no one is excluded from the disbenefits of others polluting economic activity

• Incidences of this are called public bads