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Public and Private Goods

Public Goods

A public good is one that is (1) non-rivalrous and (2) non-excludable. We will explain the meaning of these terms and illustrate them.

Non-rivalrous

This means that additional consumption of the good does not add anything to the costs of production. For example, an additional pedestrian on a well-lit street does not add to the cost of providing the street lighting.

The consequences of this is as follows. For allocative efficiency anyone wishing to consume a good should be able to do so. However, charging for a public good (in this sense, for a good, like street-lighting that is non-rivalrous) means that some people wishing to consume that good will not choose or be able to do so. Hence, for maximum welfare the price of a public good should be zero. This means that public goods cannot be produced privately, since any profit is incompatible with allocative efficiency.

Non-excludable

This means that it is not practical to exclude people who do not pay for a good from the benefit of receiving the good. Again, street lighting is a good example. It is impractical to set toll barriers around well lit streets and charge for people to walk down them! Other examples are defence and clean-streets. Both of these are provided for everyone, and everyone benefits from them regardless of who pays for it. A free-rider is someone who wants the benefit of a good but is not prepared to pay for it.

Further examples of public goods are law and order, flood protection, roads, national parks, medical and other research.

Private goods are goods that are both rivalrous and excludable. This means that consumers compete with each other to enjoy the benefits of the goods. If someone consumes a good, then another person cannot have it. An example would be a car.

The preferences of consumers for private goods are expressed through demand schedules. In other words, for private goods there is a relationship between the quantity demanded and the price charged. Consequently, the market mechanism can operate to determine the equilibrium price and quantity.

There is no demand schedule for a pure public good — one that is entirely non-rivalrous and non-excludable.

State ownership does not make a good into a public good. For example, postal services are sometimes owned by the state, but they are private goods, in the sense of being both rivalrous and excludable. A public good is one for which the market mechanism fails, either completely or in part.

Since public goods cannot be provided by the market mechanism it is argued that the government must provide them. In other words, this example of market failure is corrected by the government making a direct provision of the good.

One role of government is, therefore, to provide public goods.

Quasi-public goods

We have seen that a public good is one for which it is not practical to exclude consumers. A pure public good is one where it is impossible to exclude some consumers — if the good is provided for one person, it is provided for all. Law and order would be an example. However, if the consumption of a good can be excluded, however impractical, then the market could in theory provide a price mechanism for it. Street lighting, or perhaps, lighthouses, would be an example. Ships approaching within a certain radius of a lighthouse could send out an identifying radar signal. The ship owners could be charged for getting close to the lighthouse. Ships who do not wish to be charged could avoid the lighthouse. For this reason it is not impossible to charge for the provision of lighthouses, though still impractical. Such goods are therefore not pure public goods, and are consequently called quasi-public goods.

Mixed goods

Private goods are goods that are rivalrous and excludable. An interesting half-way house between a private and a public good is a “mixed good”. A mixed good is like a private good in that it is rivalrous and excludable, but it provides significant non-rivalrous, non-excludable external benefits for which preferences are not revealed by the market mechanism.

Examples are (a) health-care; (b) education; (c) public transport; (d) refuse collection and (e) fire-service.

Let us illustrate this in the case of education. When a person is educated he/she receives a benefit from this, which is expressed in terms of higher earnings and improved job prospects. However, the community as a whole also benefits from the individual's education, in that his/her productivity is enhanced, which is good for everyone.

The balance between private and public benefit varies, and there is debate in each case — that is, it is not easy to determine the public benefits for a good for which private preferences can be revealed by the market mechanism.

The role of the government

Pure public goods are goods where the market fails completely to reveal preferences. This is not because a supply curve cannot be drawn, nor because individual demand does not exist, but because price is not related to demand and hence a demand curve cannot be drawn. If people could be persuaded to show what they would pay for different quantities of each public good, then a market demand schedule could be constructed.

In fact, some economists claim that democracies lead to the under-production of pure public goods. Pigou claimed that people only vote on a basis of how a given proposal would affect them, and Galbraith argues that people associate public goods with state bureaucracy and tend not to vote for such goods. However, other right-wing economists argue that people vote for over-provision, since the benefits to them are obvious, and they think that others will pay the taxes.

Regarding mixed goods, the government aims to provide the optimum quantity in line with external as well as private demand. To do this the government offers subsidies or imposes taxes to or on the production of the good in order to adjust supply to the position of optimum allocative efficiency.

However, the New Right claims that the social benefits of mixed goods are so small as to provide no justification for public provision of them.

Example of a question on public goods

A government raises taxes on motorists and pays subsidies to public transport. Should the government promote public transport and act in this way?

Solution

Public transport is an example of a mixed good. That is to say, that whilst demand for public transport is both excludable and rivalrous, it has external benefits that are not expressed in a private demand schedule. Consequently, simply allowing the market to determine the provision of public transport will result in underproduction. Resources will not be allocated efficiently. This is an example of a market failure.

Underproduction of public transport results in a loss of total welfare. For example, where there is under production of public transport there will be a greater use of private transport, in the form of cars and possible private airplanes and helicopters! This leads to congestion on the roads (and airspaces) and greater use of fuel, and hence greater pollution, both locally (for example, carbon monoxide poisoning of local primary school children where their school is situated next to a congested road) and globally in the form of excess burning of fossil fuels leading to greater production of greenhouse gasses, and other noxious car fumes. All-in-all the loss of welfare from the under-production of public transport is likely to be very considerable. We also have to consider the loss of productivity as workers take longer to reach their places of employment, and everyone gets more frustrated. There will be increased accidents arising from negative psychological reactions to congestion, such as road rage.

It is generally agreed that where there is a market failure of this kind, that it is the duty of the state to provide some means of adjusting the output to restore it to the allocatively efficient position once again. Thus, taxes on motorists and subsidies to public transport are necessary and justified.