Question

explain social efficiency maximizing conditions for public good and illustrate as to how private sector unprovided public good

Answer 1

1. Public goods are those goods which are perfectly non-excludable and non-rival in consumption. Social efficiency maximizing conditions for public goods is as follows :-

● Social efficiency is maximized when the marginal costs are set equal to the sum of the marginal rates of substitution rather than taking individual's MRS into consideration. As the good is non-rival i.e it can be consumed by all consumers so society would like the producer to take into account all consumers’ preferences.

2. Private Sector underprovision of public goods :-

Private sector underprovides public goods because of the free rider problem. Let us understand with an example -

●Consider two people John and David and two consumption goods, burgers and fireworks.The prices of each good are set at $1, but fireworks are a public good. Assume that John and David have identical preferences.John and David benefit equally from fireworks. Here what matters is the total amount of fireworks. Each person chooses combinations of burgers and fireworks in which his own MRS equals the ratio of price. Marginal utilities diminish with increasing consumption of a good. In this example, optimal provision would require that fireworks is used until it's utility equals half the marginal utility of burger. Thus, each individually buys too much of the burgers privately.