Week 2: Market Failures and Public Goods (Market Failure + Public Goods)

Question 1

Public Goods

Answer 1

Collective consumption goods have the two key characteristics of being non-rivalrous and non-excludable.

Question 2

How do we classify goods?

Answer 2

1. Non-excludable
2. Non-rivalrous

Question 3

Non-excludable

Answer 3

Firms cannot exclude people from the benefits of consumption, even if they do not pay. This means that non-payers can enjoy the benefits of consumption at no direct financial cost to them. By contrast, the consumption of private goods ultimately depends on an individual’s ability and willingness to pay.

Question 4

Non-rivalrous

Answer 4

A person’s consumption of a public good does not limit the benefits available to other people. The
marginal cost of supplying a public good to an extra person is zero. If the public good is supplied to one individual, it is also available to everyone. By contrast, a person’s consumption of a private good reduces the amount available for other individuals.

Question 5

Examples of public goods

Answer 5

defence, fireworks,
tsunami siren, lighthouse,
radio

Question 6

Club goods

Answer 6

Sometimes referred to as scarce or artificially scarce goods. Excludable and non-rivalrous.

Question 7

Examples of club goods

Answer 7

toll road, gym memberships,
cable TV, online lecture videos (with password)

Question 8

Private goods

Answer 8

those whose ownership is restricted to the group or individual that purchased the good for their own consumption. A private good is not shared with anybody else but can be sold along with transferring rights to use or consume it.

Question 9

Characteristics of private goods

Answer 9

Excludable (have finite availability, making them excludable in nature by preventing others access to it) and rivalrous

Question 10

Examples of private goods

Answer 10

Phone, computer, car,
cookies, medical treatment,
education

Question 11

Common Pool Resources

Answer 11

They are not owned by any private individual or firm, so do not have a price, but are available for anyone to use without direct payment. Hence, without government intervention, these resources are vulnerable to overuse and abuse.

Question 12

Characteristics of CPR

Answer 12

Non-excludable: means that it is not possible to prevent those who are unwilling or unable to pay from benefiting once the resource is provided. These users are known as free riders. As CPRs are freely available, there tends to be over-consumption of such resources. For example, in the absence of property rights or in areas where fishing grounds are poorly protected, commercial fishing businesses will try to maximize their fish catches, thereby leading to overfishing.

Rivalrous: the usage of a resource (such as fisheries or forestries) reduces the amount that is available for others to use or consume. Common pool resources are rivalrous because consumption of these resources diminishes the quantity and possibly quality of remaining resources for the current and future generations to use. In the case of over-consumption of CPRs, sustainability becomes a real issue so generations to come may be deprived of any access to these resources.

Question 13

Tragedy of the Commons

Answer 13

This means, degradation, depletion or destruction of a common access resource caused by the problems of overuse (or abuse) and over-consumption.

Question 14

Examples of CPR

Answer 14

the commons’, clean air,
fish in the ocean, river water

Question 15

Why do private firms have no incentive to provide public goods?

Answer 15

Non-excludability means that it is not possible to prevent someone from using the public good even if they do not pay for it. Therefore, profit- maximizing firms in the private sector do not have any incentive to provide public goods. This results in public goods being under-provided, if at all, in a free market system.

Hence, once public goods are provided, they can be consumed at zero marginal cost. Since there are no incentives for the private sector to provide public goods, such as street lighting or national defense, this represents a type or cause of market failure. Instead, public goods tend to be provided by the government.

Question 16

Free Rider problem

Answer 16

Occurs when people have access to (use or benefit from) a good or service without having to directly pay for it.

Question 17

Free rider problem examples

Answer 17

If a lighthouse is built, all sailors and fishing vessels in the area can benefit, without having to contribute any payment towards it. This happens because public goods are non- excludable. This means that, those who are unwilling and/or unable to pay cannot be excluded from using the good or service if it is provided.

Question 18

Therefore existence of the free rider problem…

Answer 18

Prevents private sector firms from producing such goods and services as they are unable to charge users directly.

Question 19

Why is free-riding considered an economic problem?

Answer 19

1. leads to the under-production and/or over- consumption of a public good or service, so is highly inefficient.
2. Over-consumption and over-exploitation of public goods can often lead to the tragedy of the commons (see below), resulting in their destruction or even extinction
3. Free riders do not consider the external costs (negative externalities) of their activities, such as litter and plastic wastes left in public parks and on public beaches, possibly causing damage to the natural environment and ecosystems.

Question 20

In a standard economic model, individuals are selfish and don’t cooperate.

Yet, humans are social beings and cooperation occurs frequently. Why?

Answer 20

Altruism and Emotions (family, work, friends, community, nation, etc.)

Reciprocity (Axelrod, tit for tat, willingness to punish non-cooperators)

Fairness and inequity aversion (e.g. Capuchin monkeys here)

External enforcement (e.g. the government)

Question 21

Have these “social” aspects been integrated in mainstream economics?

Answer 21

No, this is why it is a serious limitation especially for public economics

Question 22

What is the optimal provision of public goods?

Answer 22

The Samuelson Condition - Each individual consumer’s marginal benefit, MB represents his or her demand for the public good, or willingness to pay. The sum of the marginal benefits represent the aggregate willingness to pay or aggregate demand. The marginal cost is, under competitive market conditions, the supply for public goods.

Hence the Samuelson condition can be thought of as a generalization of supply and demand concepts from private to public goods.

Question 23

Pure public good

Answer 23

A good or service that has both characteristics (non-rivalrous and non- excludability)

Question 24

Are most publicly provided goods pure public goods?

Answer 24

No

Question 25

For many publicly provided goods…

Answer 25

Consumption is to some extent rivalrous (e.g. water supply) or excludable (e.g. toll roads), or both (health care, etc.).

Question 26

If publicly provided goods are provided free of cost then?

Answer 26

Risk of overconsumption - uniform provision, queuing, user fees

Question 27

When should governments intervene in the market - according to neoclassical economics?

Answer 27

Governments need only to fix markets when encountering market failures

Question 28

Do market forces efficiently allocate resources?

Answer 28

Yes.