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Markets for public goods

October 21, 2011

Public goods are non-rivalrous meaning that when one consumer consumes a unit of the good, it does not prevent anybody else from consuming it and it does not use the good up in any way. An example of this would be the light provided by a street light. There is a cost of providing the street light, but the cost does not change when you supply a unit to an extra consumer, you can provide lighting for as many people as are on the street for the same price. So the marginal cost of providing to an extra consumer is 0.

Now think of this in efficiency terms. The Pareto efficient output would come in a competitive market where P = MC, so the efficient output here when MC = 0 is that P = 0. No private producer is going to sell at P = 0.

A private producer would only supply the good if non purchasers could be excluded and it could charge a price such that P > 0. Where exclusion is impossible, such as the street light example, then it is not profitable to produce.

When a public good is excludable then there is the possibility of private provision and a market existing for the good, but it will not be efficient, because again the non-rivalrous nature of a public good means MC = 0, and so if the private provider produces where P > 0, then P > MC and this will mean the output produced is less than the socially efficient amount.

Markets exist for public goods when they are excludable, but the market is likely to produce too little of the good.

The markets for software and music that is easily pirated are good ones to think about here. When exclusion is possible by pirating then it is not profitable to produce and sell software and music so no private providers would produce them. They only produce if there is some form of intellectual property rights protecting them. But given that the MC of producing another copy is very small, if the private producer is producing at a level where P > MC then the amount produced is less than the social optimum.

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