Figure 161

Optimal Amount of a Public Good

Aggregate demand curve DT for public good Y is obtained by the vertical summation of individual demand curves DA and DB. The reason for this is that each unit of public good Y can be consumed by both individuals at the same time. Given market supply curve SY, the optimal amount of Y is QY units per time period (indicated by the intersection of DT and SY). At QY, the sum of the individual's marginal benefits equals the marginal social costs (i.e., PT = PA + PB = MSCY).

Price and cost per unit ($)

Price and cost per unit ($)

Sy = Marginal social costs y = MSCy


Sy = Marginal social costs y = MSCy

Quantity free-rider problem

Tendency of consumers to avoid making any contribution toward covering the costs of public goods hidden preferences problem

Difficulty of determining true desires for public goods

Although the optimal quantity is QY units in Figure 16.1, there are two related reasons why less than this amount is likely to be supplied by the private sector. First, because individuals not paying for public good Y cannot be excluded from consumption, there is a tendency for consumers to avoid payment responsibility. A free-rider problem emerges because each consumer believes that the public good will be provided irrespective of his or her contribution toward covering its costs. When several people share the cost of providing public goods, consumers often believe that their individual failure to provide financial support will have no effect on the provision of the good. When many individuals behave this way, however, less than the optimal amount of the public good will be provided. This problem is generally overcome when the government initiates a tax on the general public to pay for the provision of important public goods, like national defense. In the private sector, free-rider problems are sometimes resolved through group consensus to support local zoning covenants, charitable associations, and so on.

A hidden preferences problem also emerges in the provision of public goods because individuals have no economic incentive to accurately reveal their true demand. Consumers are reluctant to reveal high demand for public goods because they fear similarly high payment demands. With private goods, the price that consumers are willing to pay provides a credible signal to producers regarding the quantity and quality that should be produced. No such pricing signals are available in the case of public goods and services. As a result, it is difficult to determine the optimal amount that should be provided.

Of course, many goods and services do not fit neatly within the categories of pure private goods and pure public goods. Examples of goods and services with some but not all of the characteristics of public goods include airports, basic research programs, day-care centers, highways, hospital facilities, immunization programs, the judicial system, parks, primary and secondary education, and trash collection. Given the many difficulties involved with accurately determining the demand for these and other quasi-public goods, it is necessary to be cautious when using the power of government to tax or otherwise compel popular support. Public policy must focus narrowly on the source of any perceived private-market imperfections and address these impediments directly.

For example, trash collection involves elements of a public good because the timely removal of trash and other debris limits the propagation of insects and rodents and, therefore, the spread of infectious diseases. Moreover, there are immense economies of density in trash collection. It is far more efficient for a monopoly trash hauler to service an entire neighborhood on a weekly basis than it is to have multiple competitors serve a single area. In recognition of the potential for problems with unregulated private-market trash collection, some local governments regulate private suppliers while others pay for this service out of general tax revenues. In theory, either approach has the potential to result in better trash collection services. In practice, regulation is seldom perfect, and local governments often find it difficult to maintain a high level of efficiency in the public provision of trash collection services.

Finally, it must be recognized that some goods and services provided by the public and not-for-profit sectors are designed to meet social goals of equity or fairness, rather than efficiency-oriented objectives. These purposes include redistributing income by giving assistance to the poor, sick, and uneducated; stabilizing economic growth; and providing for the national defense. However, efficiency considerations remain important even when these alternative objectives are important concerns of a government-sponsored or regulated program. Government has an obligation to use public funds wisely.

public choice theory

Philosophy of how government decisions are made and implemented government failure

Circumstances in which public policies reflect narrow private interests, rather than the general public interest voters

Persons who elect public officials

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