Question

What is a public good? What market problem does it cause? How can the market be corrected?

Answer 1

A public good is a good or a service whose consumption cannot be limited by the producer to paying consumers, the consumption of such a good or service by an individual does not limit the consumption of other individuals.

Public goods have 2 main characteristics:

1. Nonrivalrous consumption- The consumption of this good or service does not reduce the ability of another individual to consume it. It does not reduce the benefits derived by all other individuals.

2. Non-excludability- It means that the consumers cannot be excluded from consumption benefits. If the good is provided then no individual can be denied the consumption of that good by another individual.

The market problem that such a good causes is the problem of free riding-

The absence of excludability causes the problem of preference revelation i.e. the individuals may consume the good without having to pay for it in the hope that others will bear the cost of provision. Such a situation gives rise to the free riding problem wherein the strategy of the free rider is to reap the benefits of the good at no personal cost.

This strategy will fail the market if each individual tries to play the same strategy because if everyone tries to free rise then nothing will be provided at all. Therefore, each individual is faced with the trade off and needs to decide whether to contribute voluntarily or derive the maximum benefit by being the free rider even though when everyone contribute voluntarily they derive equal benefits.

In such a case, in order to correct the market failure there is a rationale for government intervention. The government needs to decide on laws pertaining to tarrifs, subsidies, trade restrictions and taxes in order to deal with the problem of free rider.