Market Failure: Public Goods
Updated: Nov 14, 2018
Theme 3: Market Failure and Governmental Intervention
Topic: Public Good
Relevance: H1 and H2 Economics
One of the major themes in microeconomics is the understanding of market failures and the need for government to intervene in order to correct those markets that failed. While market failures can occur in free markets and markets already with governmental intervention, the study of market failures usually starts with how the free market fails to allocate resources efficiently.
Simplistically, market failure occurs when the market does not provide the right mix of goods or the optimal amount of a particular good or service. As a result, the market is not allocating resources efficiently and society’s welfare is not maximised. Allocative Efficiency is achieved when it is impossible to make anyone better off without making someone else worse off by changing the allocation of resources. Some of the important causes of market failures are:
Public goods (continue reading)
Positive externalities in consumption (click here)
Negative externalities in production (click here)
The case of Public Good and market failure:
Public goods are any good or service with both the characteristics of non-rivalry in consumption and non-excludability.
Non-rivalry in consumption means that the consumption of the good or service by one party does not reduce the amount available to others. Public goods only need to be produced once and its marginal cost of producing public goods to an additional individual is zero (MC=0) as there is no additional resources needed to satisfy the additional individual once the good has been produced. Since producers maximize profit at the output where marginal cost is the same as marginal revenue (MC=MR), because marginal cost is zero (MC=0), producers will be unable to determine the profit maximizing output. Therefore, profit- motivated private firms have no incentive to provide the goods or services and there will be no supply in the market for public good.
Non-excludability means that there is no effective way to restrict the benefits to only those who pay for them. The benefits from public goods can be enjoyed by all, regardless of whether or not the individual pays. This feature means that one would enjoy the benefits even if they do not pay for it as long as someone else pays for it. This leads to the ‘free-rider problem’ as individuals believe that others will take on the burden of paying for public goods. Therefore, consumers will conceal their demand for the good or service from the producers and there will be no effective demand for public goods.
Therefore, due to both characteristics of non-rivalry in consumption and non-excludability, there will be no demand and supply of public goods in the free market resulting in the market failure of non-provision of public goods in the free market, no resources will be allocated to the production of public good.
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