Public goods are goods that would not be provided in a free market despite being beneficial to society. They possess two key characteristics: non-excludability and non-rivalry. Understanding these characteristics is essential for grasping why public goods require government provision and why markets fail to supply them efficiently.
Non-Excludability
Non-excludability means it is impossible to exclude non-payers from benefiting from the good once it has been provided. For example, a lighthouse provides navigation aid to all ships, and it is impossible to exclude any ship from its benefits.
The free rider problem arises because individuals can benefit from a public good without paying for it. This problem weakens the incentive for consumers to pay for public goods, as they can enjoy the benefits without revealing their demand or valuation in the market. Consequently, it is impossible to charge a market price for a public good. Private producers will not be able to collect revenue, and the lack of profitability leads to non-provision of the public good.
For instance, in the case of national defense, once it is provided, everyone in the country benefits from protection regardless of whether they contribute to its cost. Therefore, individuals have an incentive to "free ride," leading to underfunding and even a missing market if left to the market economy.
Non-Rivalry
Non-rivalry means that the consumption of the good by one person does not diminish the amount or benefits of the good to other people. For example, one person's enjoyment of a public park does not reduce the enjoyment available to others.
When the supply of a public good is not depleted by an additional user, the marginal cost (MC) of serving an additional user is zero. To achieve allocative efficiency, price should equal the MC of serving an additional user (P= MC). This means that the public good should be free of charge, implying that governments should provide the public good. This is because private producers are profit-maximizing and will not provide the good at $0.
Market Failure and Government Provision
Because of non-excludability and non-rivalry, it is impossible to charge a market price for a public good. If left to the market economy, there would be a missing market for public goods, leading to underprovision or even non-provision. Therefore, direct provision of the good by the government becomes necessary.
Advantages of Government Provision
Direct Control: The government has direct control over the quality and quantity of the amount provided, ensuring that the public good is available to all.
Addressing Market Failure: By providing public goods, the government addresses the market failure associated with non-excludability and non-rivalry.
Disadvantages of Government Provision
Opportunity Cost: The tax revenue used to provide public goods could have been spent on other government activities. This represents an opportunity cost.
Estimation Issues: Without market forces, the government may struggle to properly estimate the extent of provision necessary, potentially leading to over- or underallocation of resources.
Examples of Public Goods
National Defense: It protects all citizens regardless of individual contributions and does not diminish with more people being protected.
Public Parks: Accessible to everyone, and one person's use does not reduce its availability to others.
Street Lighting: Benefits all in the area, and one person's use of light does not diminish its availability to others.
Conclusion
Public goods present unique challenges due to their characteristics of non-excludability and non-rivalry. The free rider problem prevents efficient market provision, leading to a missing market. Therefore, government intervention is necessary to ensure that public goods are provided in a manner that maximizes social welfare, despite the potential drawbacks of opportunity costs and difficulties in estimating the required provision levels.