ChainWhat it assumes · how to break it
Start
A town needs street lighting; once a street is lit, everyone who walks down it benefits, whether or not they have paid.
1
As a result, a private firm cannot stop people who have not paid from using the light, because street lighting is non-excludable.
non-excludability
non-excludability
Assumes: There is no practical way to exclude non-payers.
But: Technology can make some goods excludable, such as road tolls or encrypted television, so a market can then work.
2
This means each person has an incentive to wait for others to pay and then use the lighting for free.
free rider problem
free rider problem
Assumes: People act only in their own self-interest.
But: Small communities can fund shared goods voluntarily, such as residents paying jointly for a private security patrol, because social pressure limits free riding.
3
Consequently, a private firm cannot collect enough revenue to cover its costs, so it has no profit incentive to provide the lighting.
profit motive
profit motive
Assumes: Firms provide only what they can sell at a profit.
But: A firm may provide a public good funded another way, for example a shopping centre lighting its own car park to attract customers.
4
Therefore, no market forms, so the good is not supplied even though people value it more than it costs to provide.
missing market
missing market
Assumes: No firm provides it in another way.
But: Some public goods are funded in other ways, such as free-to-air broadcasts paid for by advertising.
5
This means society loses the whole of the surplus the good would have created, a welfare loss on every unit up to the optimum where MSB = MSC.
welfare loss · allocative inefficiency
welfare loss · allocative inefficiency
Best link to attack
Assumes: The good's benefit to society is greater than its cost.
Assumes: The good's benefit to society is greater than its cost.
But: With no market there is no price to reveal how much people value the good, so it is hard to know whether its benefit exceeds its cost.
End
The missing market causes a welfare loss: society loses all the surplus the public good would have created, so resources are allocated inefficiently.
Evaluation chain
- E1However, the size of the welfare loss depends on how much people value the good, and no market reveals this.
- E2Because people have an incentive to understate their valuation if they expect to be charged according to it, surveys may be unreliable.
- E3As a result, the government must estimate MSB, for example through cost-benefit analysis, and may provide too much or too little.
- E4So the welfare loss from the missing market may be large, but state provision may not remove it fully if the quantity is misjudged.
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Questions this answers
- Explain why the non-provision of public goods leads to a loss of welfare.
- Analyse why public goods are not allocatively efficient when left to the market.
- Evaluate whether government provision of public goods increases welfare.
Diagram
No standard diagram. Explain that the good is non-rival, so the marginal cost of an extra user is zero and charging users would itself lose welfare.
Reverse and related
Government provision funded by taxes → the good is supplied and much of the lost surplus is recovered, if the quantity chosen is close to the optimum.