Public goods

Non-rival and non-excludable goods, the free-rider problem, why a market may provide none at all, quasi-public goods, and government provision.

Who pays for the street lights?

In Northern Ireland street lights are paid for by the Department for Infrastructure out of taxation; in Great Britain it is local councils. Nobody is charged for walking under them. When budgets are tight, some councils in Great Britain have dimmed or switched off lights late at night to save money. No firm steps in to sell lighting instead.

Why doesn’t a private firm sell street lighting, the way it sells torches?

What makes a good public?

A public good has two characteristics:

1. Non-rival: one person using it does not reduce how much is left for others. My using the street light does not dim it for you.
2. Non-excludable: once it is provided, you cannot stop people using it, even if they have not paid.

Examples: street lighting, flood defences, national defence, lighthouses. A private good, such as a sandwich, is the opposite: rival and excludable.

Because people cannot be excluded, they have an incentive to let others pay: the free-rider problem. Assumption: people act in their own interest.

Quasi-public goods.

Many goods are only partly public. A quasi-public good has some of the characteristics but not all:

• A road is non-rival when quiet, but rival when congested, and it can be made excludable with tolls.
• A public beach is non-excludable, but becomes rival on a hot day.
• Broadcast TV was non-excludable, until encryption and subscriptions made it excludable.

Technology can change a good’s character: the more excludable it becomes, the more the market can provide it.

Think first

A firm offers to put up a street light on your road.

It will light the road for everyone, whether they pay or not.

How many households are likely to pay?

Once the light is up, nobody can be stopped from using it, so each household is tempted to let the others pay and enjoy it free. With enough free riders, the firm cannot cover its costs, so it never puts the light up. That is the free-rider problem.

Step by step

1. The cost of providing street lights, MC, and what one household would pay. Each household’s own benefit is small, and free riders hide even that, so what anyone will pay is below the cost. No firm can cover its costs, so the market provides none.

2. The market output is zero: a missing market. This is the most extreme market failure: not too much or too little, but nothing at all.

   Check: Why does the free-rider problem stop a firm supplying a public good?

   Non-excludability means non-payers still benefit, so people wait for others to pay, and the firm cannot earn enough revenue.

3. But the good is non-rival, so everyone benefits from the same lights at once. Add up all the households’ benefits and the marginal social benefit, MSB, is well above the cost.

4. Society would be best off at Q*, where MSB equals the cost. The gap between zero and Q* is why governments provide public goods, paid for through taxation, so that everyone pays and nobody can free ride.

   Check: The social optimum for street lighting is where:

   Society is best off where the total benefit of the last light equals its cost.

5. So governments provide public goods directly or pay firms to provide them, funded by taxes.

A common mistake

A free rider is someone who benefits from a good without paying for it. That is possible because public goods are non-excludable.

Exam question

Explain why a free market is unlikely to provide street lighting.

Model answer

Street lighting is a public good. It is non-rival, because one person walking under a street light does not reduce the light available for others, and it is non-excludable, because once a light is up, nobody can be stopped from using it, whether they have paid or not.

Because people cannot be excluded, each has an incentive to free ride: to let others pay and enjoy the lighting for nothing. A private firm would therefore struggle to collect enough payment to cover its costs, so it would not supply street lighting at all. The result is a missing market, the most extreme form of market failure.

Yet because the good is non-rival, everyone benefits from the same lights, so the total benefit to society is greater than the cost. This is why governments provide street lighting, paid for through taxation, so that everyone contributes.

However, with no price to show how much people value the lights, the government has to estimate the benefit, so it may provide too many or too few. How well it does depends on how good that estimate is, and getting it wrong is a form of government failure.