nature and definition of free goods and private goods (economic goods)

Classification of Goods and Services (Cambridge A‑Level Economics 9708 – Topic 1.6)

Learning Objective

Explain the nature, definition and economic significance of the five main classifications of goods – free goods, private (economic) goods, public goods, merit goods and demerit goods – and classify any good or service using the concepts of scarcity, rivalry and excludability. Identify the likely market outcome and the appropriate government response.

Key Economic Concepts

• Scarcity: A good is scarce when the quantity available is limited relative to the desire for it.
• Rivalry: A good is rival if one person’s consumption reduces the amount left for others.
• Excludability: A good is excludable when it is possible to prevent non‑payers from using it.
• Opportunity Cost: The value of the next best alternative foregone when a scarce resource is used.

Decision‑Tree for Classifying a Good

Ask the three questions in order. If the good is scarce, proceed to assess rivalry and excludability; then check for externalities to decide whether it is a merit or demerit good.

1. Free Goods

• Definition: Goods that are not scarce, non‑rival and non‑excludable. Because they are abundant, no economic decision is required for their allocation and they have no market price.
• Key Characteristics
  • Supply > demand (abundant)
  • Non‑rival – one person’s use does not diminish availability to others.
  • Non‑excludable – it is impossible or impractical to prevent anyone from using it.
• Typical Examples
  • Air (in a clean environment)
  • Sunlight
  • Seawater in open oceans
• Economic Significance
  • No opportunity cost for the user; allocation is not determined by price.
  • If a formerly free good becomes scarce (e.g., clean air in a polluted city), it can shift to a private or public good, prompting government intervention such as taxes, permits or regulation.

2. Private (Economic) Goods

• Definition: Goods that are scarce, rival and excludable. Because they are scarce, choices must be made about who obtains them, usually through market prices.
• Key Characteristics
  • Scarce – limited supply relative to demand.
  • Rival – one person’s consumption reduces the amount available to others.
  • Excludable – owners can prevent non‑payers from using the good.
• Typical Examples
  • Food items (e.g., a loaf of bread)
  • Clothing
  • Automobiles
  • Private healthcare services
• Economic Significance
  • Allocation is determined by the price mechanism (supply ↔ demand). The equilibrium is shown in the diagram below.
  • Marginal Cost (MC) = Marginal Benefit (MB) at the efficient output.
  • When externalities or information failures arise, the market outcome may be inefficient, justifying government intervention (taxes, subsidies, regulation).

3. Public Goods

• Definition: Goods that are non‑rival and non‑excludable **but are still scarce** because they require resources to produce.
• Key Characteristics
  • Non‑rival – one person’s use does not reduce the amount available to others.
  • Non‑excludable – it is impossible or very costly to prevent anyone from benefiting.
  • Production incurs a cost, so the good is scarce in the sense of resource use.
• Typical Examples
  • National defence
  • Street lighting
  • Public broadcasting (basic channels)
  • Clean air (when it is scarce)
• Economic Significance
  • Free‑rider problem: because users cannot be excluded, private firms cannot capture the full benefit, leading to under‑provision.
  • Government typically finances provision through taxation.

4. Merit Goods

• Definition: Goods that are under‑consumed in a free market because they generate positive externalities (benefits to third parties) or because consumers undervalue them.
• Key Characteristics
  • Usually private, rival and excludable.
  • Social benefit > private benefit.
  • Government intervenes to increase consumption (subsidies, free provision, compulsory attendance).
• Typical Examples
  • Education
  • Vaccinations
  • Health‑promoting activities (e.g., subsidised gym memberships)
• Economic Significance
  • Market equilibrium quantity is below the socially optimal level.
  • Policy tools: direct provision, vouchers, tax credits, or legal requirements (e.g., compulsory schooling).

5. Demerit Goods

• Definition: Goods that are over‑consumed in a free market because they generate negative externalities (costs imposed on third parties) or because consumers underestimate the social costs.
• Key Characteristics
  • Typically private, rival and excludable.
  • Social cost > private cost.
  • Government intervenes to reduce consumption (taxes, regulation, bans).
• Typical Examples
  • Tobacco cigarettes
  • Alcoholic beverages
  • Sugary drinks and fast food (when linked to health costs)
  • Polluting fuels
• Economic Significance
  • Market equilibrium quantity exceeds the socially optimal level.
  • Policy tools: excise taxes, minimum age limits, advertising bans, or outright prohibition.

Comparison of All Five Classifications

Why the Distinction Matters

• Predicts who provides the good (market vs. state).
• Identifies potential market failures (free‑rider problem, externalities).
• Guides the choice of policy instruments (taxes, subsidies, regulation, direct provision).
• Links to A‑Level concepts of efficiency (allocative efficiency for private goods) and equity (distributional concerns for merit/demerit goods).

Quick‑Check Questions (AO2)

1. Explain why sunlight is a free good, but electricity generated from solar panels is a private good.
2. Identify a good that can be either free or private depending on circumstances, and describe those circumstances.
3. Classify each of the following using rivalry and excludability, then state the likely government response:
   • (a) Public parks
   • (b) Toll roads
   • (c) Broadcast television (free‑to‑air channels)
4. Give one example of a merit good and one of a demerit good. For each, explain the externality involved and a typical government policy used to correct the market outcome.
5. Using the decision‑tree, classify “clean air in a heavily polluted city”. What policy instruments could be used to address its scarcity?

Application Checklist for Students (AO2/AO3)

• Is the good scarce?
• Is it rival or non‑rival?
• Is it excludable or non‑excludable?
• Are there positive or negative externalities? → merit or demerit?
• State the likely market outcome (price, quantity, provision).
• Justify any recommended government intervention and name the appropriate policy instrument.