1. Market Failure – Public Goods

2. Market Failure
Public Goods

3. What are Public Goods?
1. Non-excludability: The benefits derived from pure public goods
cannot be confined solely to those who have paid for it. Non-
payers can enjoy the benefits of consumption at no financial cost
to themselves – economists call this the ‘free-rider’ problem
2. Non-rival consumption: Each party’s enjoyment of the good or
service does not diminish others’ enjoyment– in other words the
marginal cost of supplying a public good to an extra person is zero.
If a public good is supplied to one person, it is available to all.
3. Non-rejectable: The collective supply of a pure public good for all
means that it cannot be rejected by people, an example is a
nuclear defence system, armed forces or flood defence projects.
The nature of public goods is that it is hard to protect property rights
Public goods cause market failure due to missing markets – their
main characteristics are as follows:

4. Examples of Public Goods
Pure public goods are non-excludable and non-rival in consumption
Sanitation
infrastructure
Flood defence /
tidal barrage
Crime control for
a whole
community
Reduced risk of
disease from
vaccinations
Freely available
knowledge e.g.
online learning
Public service
broadcasting
Public goods
are also
known as
collective
consumption
goods

5. Quasi Public Goods
• A quasi-public good is a near-public good
i.e. it has many but not all the characteristics
of a public good.
• Quasi public goods are:
1. Semi-non-rival: up to a point, more
consumers using a park, beach or road do
not reduce the space available for others.
But eventually beaches become crowded
as do parks/leisure facilities. Open-access
Wi-Fi networks become crowded
2. Semi-non-excludable: it is possible but
difficult or costly to exclude non-paying
consumers. E.g. fencing a park or beach
and charging an entrance fee; or building
toll booths on congested road routes

6. Public Goods, Market Failure and Free-Riders
• Pure public goods are not normally provided by the private sector
because they would be unable to supply them for a profit.
• It is up to the government to decide what output of public goods
/ funding of public goods is appropriate for society.
• To do this, it must estimate the net social benefits from making
public goods available.
• The Free-Rider Problem
– Because public goods are non-excludable it is difficult to
charge people for benefitting once a product is available
– The free rider problem leads to under-provision of a good and
thus causes market failure
With public goods, private sector markets may fail to supply in part
or in whole the optimum quantity of public goods

7. The Changing Nature of Public Goods
Advances in technology are causing a blurring of the distinction
between public and private goods. Here are some examples.
Encryption
devices
Smart Electronic
Road Pricing
Open Source
Software
Live Streaming
of Events
• In some cases, encryption
allows suppliers to exclude
non-payers – although the
product remains non-rival
• Technological progress
reduces the cost of smart-
metering used in road pricing
– this makes roads more of a
private (excludable) good
• The open source / creative
commons movement has
made much information
public good in nature

8. Should the Government Provide Public Goods?
The state finances many public goods but should it always provide?
1. The non-rival nature of consumption provides a strong case for the
government rather to provide and pay for public goods
2. Many public goods are provided free at the point of use and then
funded by taxation or a charge such as the BBC’s licence fee
3. State provision may help to prevent under-provision and under-
consumption of public goods so that social welfare is improved
4. If the government provides public goods they may be able to do so
more efficiently because of economies of scale
5. Providing essential public goods helps affordability and access to
important services for lower income households and therefore help to
address inequalities of income
6. If the government becomes a monopoly provider, there is a danger of
a lack of efficiency arising from a lack of competition
7. In some cases the state will fund and the private sector provides
public goods e.g. Public Private Partnerships

9. Excludability and Rivalry – Different Goods & Services
Totally non-rival in
consumption
Totally rival in
consumption
Totally excludable Totally non-excludable
Encrypted
digital
broadcasting
Analogue
broadcasting
National
defence
systems
Toll Bridges
Vaccinations for
the general
population
Common
Land
Private
Parks
Public Firework Displays
Sports Tickets to
a Major Event

10. Global Public Goods
Global public goods benefit every country, irrespective of which
ones provide them – they have become more important recently
1. Security from war, violence, and crime
2. The rule of law, property rights, and contract enforcement
3. Eradication of smallpox, Ebola and other diseases
4. Non use / proliferation of nuclear weapons
5. Agreements/measures towards protection of the ozone layer
EbolaControl
Environment

11. Public Bads
• A public bad has negative effects (externalities) on people and their
communities leading to a significant loss of social welfare
• Examples of public bads:
1. Spread of infectious diseases such as Ebola
2. Unauthorized / illegal surveillance by the state
3. Modern slavery / human trafficking
4. Environmental threats to the global commons
5. Gender and other forms of discrimination in labour markets
6. Disposal of household and commercial waste
7. Web viruses / denial of service attacks
8. High rates of global inequalities of income and wealth
9. Endemic corruption within organisations and societies
10. Externalities from banking crises / financial mismanagement
Key Point: Arguments about whether market activity lead to public bads almost
inevitably involves making normative statements that carry value judgements

12. Cost Benefit Analysis
• Cost benefit analysis is a process used to measure the estimated
net social rate of return from an investment project.
• When governments are deciding how much to spend on public
goods, they might use a cost-benefit approach to aid them
• A typical cost benefit analysis involved the following process:
1. Set the key objectives for the project
2. Set project decision criteria i.e. an acceptable benefit to cost ratio
3. Identify and value the private & external costs of the project
4. Identify and value the private & external benefits of the project
5. Consider possible distributional effects e.g. on inequality
6. Discount annual value of benefits that will happen in the future
7. Adjust for various risks and uncertainties
8. Consider the unvalued / non-monetized costs and benefits
9. Measure the expected net social return from the project
10. Compare with expected net social returns from other projects i.e.
the opportunity cost of £billion invested in a project

13. Evaluation: Problems with Cost Benefit Analysis
Assigning monetary values
• Some aspects of a project can be
assigned a monetary value
• Time savings e.g. For
passengers and businesses
• Operating costs of the project
• Value of carbon emissions e.g.
Lower CO2 from less car use
• Risk of death or injury
• Other variables are much harder
to assign values
• Bio-diversity
• Water quality
• Air quality
• Heritage
• Social inclusion / accessibility
Uncertainties and Risks
• There are uncertainties involved
in major projects with long
construction times + operating
life that can last decades
• Forecast errors for passenger
numbers in different modes
of transport
• Uncertainties about
population growth
• Uncertainties about future
operating costs (including
energy prices)
• Future business growth /
types of businesses / impact
of new technologies
Supporters of major projects may suffer from optimism bias when evaluating a project

14. Public Goods and Externalities
Infrastructure projects often have a public good aspect and generate
external benefits and costs both during & after construction has taken
place. Cross Rail is our example here.
Type Costs Benefits
Private • Construction costs
• Operating costs
• Cost of capital (interest on
loans)
• Potential health and safety
costs / insurance liability
• Lower transport costs for
businesses
• Time savings for travellers and
businesses
• Potential innovation spill-overs
and export potential in and
around London
External • Externalities from
construction
• Landscape issues
• Increased noise /
congestion in and around
new stations
• Regeneration in potentially
deprived communities
• Potential re-skilling of
workforce employed
• Lower CO2 and other emissions

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