Question

Evaluate real-world instances of externalities and public good inefficiencies and suggest solutions. Describe a situation where you experienced a positive or negative externality or free-riding by you or someone else. Why are these situations problematic?

Answer 1

Introduction

A public good is one, which is sold to the public at large, and is not restricted in use to anyone at all. It in most cases is provided by the government which finances it through tax collections in a country, however there may be some instances in which private players are granted contracts to provide for the public at a price and make reasonable profits from the same.

Public goods are provided for a relatively cheaper rate to the mass population to allow them to grow and are mostly critical to the functioning of a country. Some examples of a public good include electricity, police, defence, water, health, education etc.

Public goods may have positive or negative externality, which refers to the emergence of positive outcomes or negative interactions apart from the transaction itself. For example, providing education helps in building skills in the economy which in turn also has a positive outcome towards employment, income inequality and poverty reduction.

Case Specifics: -

Public Good Inefficiencies: -

In socialist countries, wherein the government has direct control over what goods and services would be produced in the nation, prior to the time period between 1960-1990's, when countries such as China and India were socialist in their approach. All services including radio, transport, airways, manufacturing etc were held by the government at large and were provided as public goods to the majority of the people. This however led to inefficiency in management as the companies which were thus formed out of the arrangement were not profitable and the governments had to incur substantial capital losses as people would pay only a fraction of the total cost of operations. This led to negative externality wherein, the total expenditure of the government exceeds its revenue and the currency exchange fell as the demand was lesser than the overall supply.

To avoid such situations, it is recommended that only those goods and services remain public, which are of national interest and are strategic in nature such as defence, police etc. All other services may have both government and private participation in which the customers are free to choose their operators example education, health care, etc.

This gives the government the upper hand of allowing services at lower rate and productivity for those who do not afford to pay as much and would still get the benefits of a lower entry price on one hand, and on the other the private sector would play a pivotal role in allowing for these industries to grow at the same time.

Externality Example: -

The education sector is a prime example of positive externality which has happened. Most people know of others who have availed education and were previously from humble backgrounds, but simply because of education their skills today are updated and have allowed them to live better lives for themselves. The effects of education are felt in the growth rate and the spending capacity and employment opportunities which help an economy grow.

Over the years, we have observed how government expenditure on education and allowing it as a public good has allowed numerous underdeveloped economies such as China and India to come out of extreme poverty and provide for its population at large.

Please feel free to ask your doubts in the comments section.