Public goods and common resources
Markets work well for most goods, but some goods have features that make markets produce too little or use them up too fast.
What market failure means
Market failure occurs when a free market, left alone, does not produce an efficient outcome: total surplus could be increased by changing what is produced or who gets it. Main sources are public goods, common resources, externalities, information problems, and market power.
Excludability and rivalry
Goods are classified by two features. Excludable: people who do not pay can be kept from using it. Rival: one person's use reduces what is available to others. Private goods (a sandwich) are both; public goods (national defence) are neither; common resources (ocean fish) are rival but not excludable; club goods (streaming services) are excludable but not rival.
Public goods and free-riding
Because no one can be excluded from a public good, people can benefit without paying: the free-rider problem. Private firms struggle to sell such goods, so markets underprovide them. Examples include national defence, street lighting, flood defences, and basic scientific research. Governments usually fund them through taxes.
Deciding how much public good
The efficient quantity of a public good is where the sum of everyone's marginal benefits equals marginal cost, because everyone consumes the same unit. Cost-benefit analysis estimates these values, though people have incentives to misstate how much they value a good they will not pay for directly.
Common resources and the tragedy of the commons
Common resources are rival but non-excludable. Each user gains the full benefit of using more but bears only part of the cost of depletion, so the resource is overused. Garrett Hardin's 'tragedy of the commons' describes this for shared pastures; modern examples include overfishing, groundwater depletion, and congested roads.
Solutions for common resources
Solutions include regulation (catch limits, hunting seasons), taxes or fees (congestion charges), tradable permits (fishing quotas that can be bought and sold), and assigning property rights. Elinor Ostrom, the first woman to win the economics Nobel Prize (2009), showed that local communities often manage commons successfully through their own rules.
Worked example
In a shared lake, each fisher earns money from extra catches, while the cost of a smaller fish population is spread over everyone. Fishers keep fishing until stocks collapse, as happened to Atlantic cod off Newfoundland in the early 1990s. Introducing individual tradable quotas caps the total catch and gives each holder a stake in a healthy stock.
Club goods and natural monopoly
Club goods are excludable but not rival, at least until crowded: cable TV, private parks, software. Because extra users cost almost nothing, they are often supplied by natural monopolies, raising the regulation questions covered earlier.
Key takeaways
Market failure means the market outcome is inefficient. Goods are classified by excludability and rivalry. Public goods are non-excludable and non-rival, so free-riding leads to underprovision and government provision. Common resources are rival but non-excludable, leading to overuse. Quotas, fees, property rights, and community rules can manage commons.
Flashcard
Market outcome is inefficient
Check your understanding
Street lighting is a public good because: