public goods and private goods

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Cambridge International AS & A Level Economics – Public Goods, Private Goods and Market Failure

1. The Economic Problem and Key Concepts

  • Scarcity: Unlimited wants vs. limited resources.
  • Choice at the margin: Decisions are made by comparing marginal benefit (MB) with marginal cost (MC).
  • Efficiency: Resources are allocated where MB = MC (the social optimum).
  • Time: Short‑run vs. long‑run analysis (elasticities, factor adjustment).
  • Progress & Development: Growth in real GDP, improvements in living standards and reduction of poverty.

2. Classification of Goods (Syllabus 1.1‑1.6)

Goods are classified according to two binary properties – rivalry and excludability. The table below shows the four categories and the relevant syllabus codes.

Category Rivalry Excludability Syllabus code
Private goods Rival Excludable 1.6
Public goods Non‑rival Non‑excludable 1.6
Common‑pool resources Rival Non‑excludable 1.6
Club goods Non‑rival Excludable 1.6

3. Private Goods

  • Characteristics
    • Rivalrous – one person’s consumption reduces the amount available for others.
    • Excludable – producers can prevent non‑payers from using the good (price mechanism).
  • Market outcome
    • Competitive markets allocate efficiently: MB = MC (or, in demand‑supply terms, P = MC).
    • Total surplus = Consumer surplus + Producer surplus (maximised).
  • Examples – smartphones, shoes, a cup of coffee.

4. Public Goods

  • Characteristics
    • Non‑rivalry – one person’s use does not diminish the ability of others to use it.
    • Non‑excludability – it is difficult or impossible to prevent anyone from benefiting.
  • Implications for the market
    • Firms cannot charge each user → price mechanism fails.
    • Free‑rider problem: individuals have an incentive to under‑state their willingness to pay, hoping others will pay.
  • Social vs. Private Benefit
    • Marginal Private Benefit (MPB) = individual’s willingness to pay.
    • Marginal External Benefit (MEB) = benefit to others from one additional unit.
    • Marginal Social Benefit (MSB) = MPB + MEB.
      Note: The vertical distance between the MPB and MSB curves at any quantity equals the MEB.
    • Because firms capture only MPB, they produce where MPB = MC, which is below the socially optimal level where MSB = MC.
  • Examples – national defence, public parks, street lighting, disease‑eradication programmes.

5. Externalities and Market Failure (Syllabus 7.3‑7.4)

  • Externalities are costs or benefits that affect third parties not involved in the transaction.
    • Positive externalities – education, vaccination, R&D.
    • Negative externalities – pollution, noise, traffic congestion.
  • Market failure occurs when the market outcome is not socially efficient, i.e. MSB ≠ MC for positive externalities or MSC ≠ MB for negative externalities.
  • Link to public goods – Public goods generate a positive externality for every additional user, creating the free‑rider problem and resulting in under‑provision.

6. Government Intervention (Syllabus 3.1‑3.3)

To correct market failure, the government can use the following tools. The table also indicates the typical situation in which each tool is appropriate.

Tool (Syllabus code) Typical use Example
Direct provision (3.1) When a good is non‑excludable and non‑rival, and the market will under‑provide. National defence, street lighting.
Indirect taxes (3.2) To internalise negative externalities (make MC = MSC). Cigarette tax, carbon tax.
Subsidies (3.2) To internalise positive externalities (raise MPB towards MSB). Education vouchers, renewable‑energy grants.
Price controls – ceilings/floors (3.2) When price is above or below the socially optimal level. Rent control (ceiling), minimum wage (floor).
Buffer‑stock schemes (3.3) To stabilise markets for commodities with large price fluctuations. Government grain reserves.
Provision of information (3.3) To correct information asymmetry and encourage socially beneficial behaviour. Health warnings on tobacco packs.

7. Government Failure (Syllabus 8.1.2)

  • Inefficiency – Public sector may produce at higher cost than the private sector (bureaucracy, lack of profit motive).
  • Rent‑seeking & political bias – Policies may favour special interest groups rather than society as a whole.
  • Fiscal constraints – High taxation can distort labour supply and savings.
  • Equity concerns – Exclusion mechanisms (e.g., tolls) may disadvantage low‑income households.

8. Diagram – Social vs. Private Marginal Benefit for a Public Good

Diagram showing MPB, MSB and MC curves with equilibrium points
How to draw the diagram (exam checklist)
  • Y‑axis: Price / Value (£)
  • X‑axis: Quantity (Q)
  • Draw the MPB curve – downward sloping.
  • Draw the MSB curve above MPB – the vertical gap at any Q equals the MEB.
  • Draw the MC curve – usually upward sloping.
  • Label point A where MPB = MC (market equilibrium – under‑provision).
  • Label point B where MSB = MC (socially optimal equilibrium).
  • Shade the area between MSB and MPB from Q = 0 to Q = B and label it unrealised social surplus (the dead‑weight loss from the free‑rider problem).

9. Evaluation – When Should the Government Provide Public Goods? (AO3)

Argument Supporting evidence / reasoning Limitation / counter‑argument
Government provision ensures the socially optimal quantity (MSB = MC). Eliminates free‑rider problem; examples: national defence, public broadcasting. Public sector may be less efficient; risk of bureaucratic waste and political bias.
Financing via taxation spreads the cost fairly across beneficiaries. Progressive taxes can align ability to pay with benefit received. Tax resistance or evasion can reduce available funds; high taxes may distort labour supply.
Subsidies can harness private‑sector innovation while still achieving higher output. Renewable‑energy subsidies have expanded clean electricity generation. Poorly targeted subsidies may cause “crowding‑out” of private investment and create fiscal pressure.
Private (or semi‑private) provision is feasible when excludability can be enforced. Pay‑as‑you‑go schemes for toll roads avoid free‑riding. Excludability mechanisms can be costly; may exclude low‑income groups, raising equity concerns.

10. Summary of Key Points (AO1)

  • Private goods: rival & excludable → competitive markets allocate efficiently (MB = MC).
  • Public goods: non‑rival & non‑excludable → free‑rider problem → market under‑provides (MPB = MC < MSB).
  • Externalities are a broader form of market failure; positive externalities often accompany public goods.
  • Government intervention (3.1‑3.3) can correct failure through direct provision, taxes, subsidies, price controls, buffer‑stock schemes, or information provision.
  • Government failure (8.1.2) must be considered when evaluating policy options.
  • Evaluation should balance efficiency gains against possible inefficiency, equity, and fiscal constraints.

11. Assessment Objective Prompts (AO1‑AO3)

  1. AO1 – Knowledge & Understanding
    • Define: rivalry, excludability, private good, public good, free‑rider problem, externality, marginal private benefit (MPB), marginal external benefit (MEB), marginal social benefit (MSB).
    • State the equilibrium conditions for private goods (MB = MC) and public goods (MSB = MC).
    • Label a diagram of MPB, MSB and MC correctly, including points A and B and the shaded unrealised social surplus.
  2. AO2 – Application & Analysis
    • Given a table of private demand and external benefit, calculate MPB, MSB and identify the market and socially optimal quantities.
    • Analyse how a change in government tax policy (e.g., a subsidy) would shift the MPB curve and affect the quantity of a public or semi‑public good.
  3. AO3 – Evaluation
    • Discuss the advantages and disadvantages of government provision versus private provision of a specific public good (e.g., street lighting).
    • Evaluate the likely impact of a subsidy on the quantity of a semi‑public good, considering possible crowding‑out, fiscal sustainability and equity.

12. Quick Reference Table – Private vs. Public Goods

Feature Private Goods Public Goods
Rivalry Yes – consumption by one reduces availability for others. No – one person’s use does not affect another’s.
Excludability Yes – producers can prevent non‑payers from consuming. No – difficult or impossible to exclude non‑payers.
Typical market outcome Efficient allocation (MB = MC). Under‑provision (MPB = MC < MSB).
Typical examples Food, clothing, cars, smartphones. National defence, public parks, street lighting, disease control.
Policy response Left to market forces; regulation may be needed for negative externalities. Direct provision, taxation, subsidies, price controls, buffer‑stock schemes, or regulated private provision.

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