Question

a) Explain carefully why the demand curve for a public good is correctly found by taking the vertical summation of the individual consumers’ demand curves, and why the efficient quantity frequently won’t be produced when left up to the free market (with no government intervention). Use one or more appropriate diagrams to illustrate your answer.   

b) Explain why redistributive policies (that involve taxing higher earners and redistributing some of these returns to lower earners) can give rise to an equity/efficiency trade-off.

Answer 1

a) The demand curve for public good is found by vertical summation because of the feature of public goods being non rival and non excludable. This means that when a public good is consumed, its amount would not reduce for other consumers' consumption and hence everyone would be able to get the same amount of public good. Eg: defence services. If the defence services are proetcting citizen A, it does not imply that the services would reduce for Citizen B.

The graph above shows the vertical summation where da, db and dc are the individual demand curves and DD is the aggregate demand curve for the public good.

Efficient quantity of public goods is not produced when left to private markets. This is because the market fails to consider the benefits or costs, the society has from the consumption of a good and hence it is either overproduced or underproduced.

Eg: Vaccination: It is a type of good that provides positive externality. Hence it should be produced more than it is, when left to the market mechanism. This would mean that if it is provided as a public good, then the optimal level would be provided.

In the graph above, the positive externality is shown and Qm is the quantity which should have been produced rather than Q, which would be produced if left to market mechanism.

b) Redistributive policies are undertaken by the government or other such national institutions to provide welfare to the weaker sections of the society. It could be in the form of higher taxes for the richer sections and then using it to provide essential goods, food stamps. But this could result in a tradeoff between efficiency and equity. Efficiency is when the society is able to get the maximum from the use of resources in the economy and equity is redistribution of resources such that even the weakest person of the economy is taken care of.

In this tradeoff, if the government has the focus on the welfare and the equity is being focussed upon, then the efficiency would be compromised and vice versa.

(You can comment for doubts)