Module XII·Article II·~1 min read
Public Goods and the Free Rider Problem
Market Failures
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Public goods and the free rider problem are a special class of goods that the market cannot efficiently provide. This is the most important justification for government intervention.
Characteristics of public goods
- Non-rival: consumption by one person does not reduce availability for others.
- Non-excludable: it is impossible to exclude non-payers.
Examples:
- National defense
- Street lighting
- Fundamental science
- Clean air
The Free Rider Problem
Free rider problem: a rational individual will not pay for a good if they can use it for free.
Result: underproduction or non-production of public goods by the market.
Everyone thinks: "Let others pay, and I will use it."
If everyone thinks this way — no one pays.
Classification of goods
| Excludable | Non-excludable | |
|---|---|---|
| Rival | Private goods | Common resources |
| Non-rival | Club goods | Public goods |
- Private goods: apple, car — the market works.
- Club goods: cable TV, swimming pool — can be excluded, but no rivalry.
- Common resources: fish in the ocean — "tragedy of the commons".
- Public goods: defense — requires government provision.
Government Provision
Solution: the government produces or finances public goods with tax revenue.
Problems:
- Determining the optimal level
- Political distortions
- Inefficiency of government production
For the investor
- Government expenditures: understanding government spending structure — which industries are beneficiaries.
- Infrastructure: often a public good — government financing.
- Privatization: some “public” services can be privatized with proper design.
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