Public goods

    The third main category of market failure arises because of the existence of public

goods. A public good is defined as being non-excludable and non-rivalrous in consumption.A private good, by contrast, is both excludable and rivalrous in consumption.

    For the explanation of these concepts, consider the example of an army, representing a pure public good, and an apple, a private good. A good is excludable if individuals can be prevented from enjoying its benefits. It is easy to withhold an

apple from someone, hence it is excludable. However, if an army successfully

defends a country against an invading force, then all inhabitants of the protected

country necessarily benefit and no one can be excluded. National defence is thus non-excludable.

    Non-rivalry means that the consumption of a good by an additional person

does not preclude someone else also consuming it. Put more technically, a nonrivalrous good is subject to a zero marginal cost of consumption. If one individual

eats the apple, this precludes anyone else from eating it. Apples are thus

rivalrous goods. If the army protects the nation, however, all citizens are free to

enjoy the feeling of security that protection engenders. The fact that I feel secure

does not in any way preclude your feeling secure, nor does it add to the security

bill. Consequently, national defence is also a non-rivalrous good.

    Public and private goods do not constitute sharply delineated categories. There

is a continuous range of products between the two opposite poles, pure public

goods and pure private goods. Figure 8.3 tentatively places some examples of different goods within this continuous range, differentiating between the intensity

of rivalry and the degree of excludability of these goods. The fact that most goods

are roughly situated around the diagonal starting at the origin illustrates that

there is a strong link between rivalry and excludability.

    In the bottom left corner of the diagram are listed some pure public goods. If a

country’s air is clean, if its territory is safe from foreign armies and if its currency is

stable, then the benefits of these achievements can be withheld from no citizen of

this country, nor does it cost more to provide them if the resident population grows.

They are, therefore, unambiguously non-excludable and non-rivalrous. At the other

extreme are pure private goods, situated in the top right corner of Figure 8.3. Apples,

cars and books are clearly excludable and rivalrous. The most interesting cases,

however, are located between these two poles. Museums and art galleries are to some extent non-rivalrous. My enjoyment from viewing a Caravaggio today in no sense diminishes the possibility of your enjoying it tomorrow – hence it is non-rivalrous.But if everybody crowds into the gallery at the same time, each person’s enjoyment will diminish and, in that sense, the art gallery becomes a rivalrous good. It is also excludable – one can change the admission fee to the gallery.

    Another example of a good which is only partly ‘public’ by nature is a motorway.

Again, up to a certain point of congestion, additional users cause only minor, if any, diminution of existing users’ utility. It is also possible to exclude certain drivers from the use of these roads by setting up checkpoints or toll booths. Obviously, it is more costly to control the access to a motorway than to monitor the entrance of a museum or art gallery. A motorway is thus less ‘excludable’ than a museum. This is important, because very few things are technically non-excludable. As technology changes, some things become less excludable and some more excludable .The real issue is the cost of exclusion, which is an example of transaction costs. Also, improved technology and income growth have made some hitherto non-rivalrous goods become rivalrous.

    Markets fail in the presence of pure public goods because of the so-called ‘freerider’ problem. It may be very costly to provide a public good,but everyone can benefit from it no matter whether he or she has contributed to its financing. Self-interested individuals have an incentive to avoid paying for the good in the hope that others will provide it. In other words, utility-maximising individuals try to free-ride on the others. If all individuals reason in that fashion,none of the public good is produced, even if the aggregate cost of providing the good is much lower than the sum of potential utility gains. The market, a system based on non-cooperative interaction of selfish individuals, leads to zero provision of pure public goods. If the aggregate benefit potentially derived from the public good exceeds its total cost of provision, this could be a very inefficient outcome. The non-rivalrous character of a public good means that the market should produce more than it does, while its non-excludable character means that the market will never have the incentive to do so.