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AS Market Failure

Public and Private Goods

Public goods provide an example of market failure resulting from missing markets. To understand this it is helpful first to discuss what is meant by a private good or service.

Private Goods

A private good or service has three main characteristics:

1. Excludability: Consumers of private goods can be excluded from consuming the product by the seller if they are not willing or able to pay for it. For example a ticket to the theatre or a meal in a restaurant is clearly a private good. Another example is the increasing use of “pay-per-view” as a means of extracting payment from people wanting to watch exclusive coverage of sporting events on television or the payment required to travel on a toll-road or toll-bridge. Another example of a private good is the use of subscription-based services on the internet. Some newspapers provide the bulk of their news stories on the internet as a “quasi public good” such as The Guardian www.guardian.co.uk. Others are developing an alternative business model where users can only access premium services through password-protected parts of a web site that require payment from consumers – examples include The Economist www.economist.com and the Financial Times www.ft.com. Excludability gives the service provider (the seller) the chance to make a profit from producing and selling the product. As we shall see, with public goods, such excludability does not exist. When goods are excludable, the owners can exercise property rights.
2. Rivalry: With a private good, one person's consumption of a product reduces the amount left for others to consume and benefit from - because scarce resources are used up in producing and supplying the good or service. If you order and then enjoy a pizza from Pizza Hut, that pizza is no longer available to someone else. Likewise driving your car on a road uses up road space that is no longer available at that time to another motorist. The greater the volume of traffic on the roads, the higher the likelihood of traffic congestion which has the effect of reducing the average speed and increasing the average journey time for each road user.
3. Rejectability: Private goods and services can be rejected - if you don't like the soup on the college or school menu, you can use your money to buy something else! You can choose not to travel on Virgin Rail on a journey to the North West and go instead by coach, or you can choose not to buy a season ticket for your local soccer club and instead use the money to finance a subscription to a local health club. All private goods and services can be rejected by the final consumer should their tastes and preferences change.

Characteristics of Public Goods

As one might expect, the characteristics of pure public goods are the opposite of private goods:

• Non-excludability: The benefits derived from the provision of pure public goods cannot be confined to only those who have actually paid for it.  In this sense, non-payers can enjoy the benefits of consumption at no financial cost to themselves – this is known as the “free-rider” problem and it means that people have a temptation to consume without paying!
• Non-rival consumption: Consumption of a public good by one person does not reduce the availability of a good to everyone else – therefore we all consume the same amount of public goods even though our tastes and preferences for these goods (and therefore our valuation of the benefit we derive from them) might differ

Examples of Public Goods

There are relatively few examples of pure public goods. Examples of public goods include flood control systems, some of the broadcasting services provided by the BBC, public water supplies, street lighting for roads and motorways, lighthouse protection for ships and also national defence services.

Public goods and market failure

Pure public goods are not normally provided at all by the private sector because they would be unable to supply them for a profit. Thus the free market may fail totally to provide important pure public goods and under-provide quasi public goods (see below).

It is therefore up to the Government to decide what output of public goods is appropriate for society. To do this, it must estimate the social benefit from the consumption of public goods. Putting a monetary value on the benefit derived from street lighting and defence systems is problematic. The electoral system provides an opportunity to see the public choices of voters but elections are rarely won and lost purely on the grounds of government spending plans and the turnout at elections continues to fall.

The air waves – a public good or a quasi public good?

The airwaves used by mobile phone companies, radio stations and television companies are essentially owned by the government of a particular country.

Do they count as a pure public good? Normally the answer would be yes. One person’s use of the airwaves rarely reduces the extent to which other people can benefit from utilising them. But when demand for mobile phone services is high at peak times, the airwaves become crowded and as a result access to the networks can become slow. In this sense the airwaves can be treated a crowded non-pure public good.

The government also controls the issue of licences needed to operate mobile phone services using the airwaves in the UK. In 2000, they auctioned off five licences for 3rd generation mobile phone services and raised £22 billion in doing so.

Quasi-Public Goods

Most public goods are non-pure public goods – these are also known as quasi-public goods. The main reason is that we can find ways and means of excluding some groups from consuming them!

A quasi-public good is a near-public good i.e. it has many but not all the characteristics of a public good. Quasi public goods are:

• Semi-non-rival: up to a point, extra consumers using a park, beach or road do not reduce the amount of the product available to other consumers. Eventually additional consumers reduce the benefits to other users. Beaches become crowded as do parks and other leisure facilities.
• Semi-non-excludable: it is possible but often difficult or expensive to exclude non-paying consumers. E.g. fencing a park or beach and charging an entrance fee; building toll booths to charge for road usage on congested routes

The diagram below is one way of illustrating the different characteristics of public and private goods.

The BBC as a public good

Broadcasting is a good example of a public good. Let us remind ourselves of the three main characteristics of a public good.

Firstly it is non-rival, meaning that the consumption of a public good or service by one individual does not preclude consumption by another individual. Secondly, consumption is non-excludable. This means that consumption by one individual makes it impossible to exclude any other individual from having the opportunity to consume. Effectively the cost of providing a pure public good to an extra user is zero, and this implies that, in order to achieve allocative efficiency, the charge for the product should be zero. Of course, in this situation, private sector businesses are unlikely to consider providing pure public goods because they will not be able to make any profit at a zero price, and many consumers can take a free ride on such goods because of non-excludability.

The provision of pure public goods is therefore a cause of market failure. Left to the free market, public goods are under-provided and under-consumed leading to a loss of social welfare.

At the moment, around 23 million households in Britain pay an annual licence fee. All of these people are stakeholders in the debate about the future funding of the BBC and the vast majority use one or more BBC services at least once a week. The fee is a means of providing collective payment for a public good. We know that there are fee-dodgers who try to take a free-ride by avoiding payment, but there are well established although costly means to enforce the licence fee and take non-payers to court.

Of course the BBC is now facing huge competition from broadcasters such as Sky who are able to exclude people from their services through the use of subscription-based services. Sky’s financial muscle continues to grow.

The case for government intervention in the case of public goods

• The non-rival nature of consumption provides a strong case for the government rather than the market to provide and pay for public goods.
• Many public goods are provided more or less free at the point of use and then paid for out of general taxation or another general form of charge such as a licence fee.
• State provision may help to prevent the under-provision and under-consumption of public goods so that social welfare is improved.

Public bads

A public bad is the opposite of a public good – it provides disutility or dis-satisfaction to people when consumed and therefore reduces our economic welfare. A good example to look at would be the disposal of household and commercial waste.

People are normally prepared to pay a price for their household waste to be collected and disposed of in a safe and non-polluting way. But if waste was changed for according to how much had been generated, then some people would find an incentive to dump their waste on other people’s property and thereby avoid direct charges.