Market Failure Notes

1. Public Goods 1.1. The Free-Rider Problem and Complete Market Failure Public goods are goods with features of non-rivalry and non-excludability in consumption and thus, would not be provided by the free market. Non-excludability suggests that it is technically impossible or economically unfeasible to exclude anyone from the benefit of the good once it is provided. In the case of street lighting, it is impossible to provide the lights and yet prevent passers-by from enjoying the benefits from seeing the light. Hence, once street lighting is provided, it will benefit everyone who walks under it, regardless of whether the person has paid for it or not. Since non-payers would be able to enjoy the benefits of street lighting for free, this would deter anyone from deciding to pay for it in the first place and this creates the free-rider problem. Thus, the demand for public good is concealed. Therefore, in a free market, there is no price signal for producers to charge a price and given there are costs of providing the good (thus making a loss), producers will not allocate resources to produce it i.e. under allocation of resources causing allocative inefficiency. Non-rivalry suggests that the consumption of the good by one person does not reduce the benefit of the good available to others. In the case of street lighting, when one person walks under the streetlamp, the brightness level will be the same as when two or three people were to walk under it. This suggests that an additional consumption of the good does not deplete its benefits. Hence, the marginal cost (MC) of providing street lighting for an additional user is zero. To achieve allocative efficiency where P = MC, street lighting has to be provided at no charge i.e. P = 0. However, no private firms will be willing to produce street lights at P = 0 given there are costs of providing it. Alternatively, if they were to provide street lights, they would have to charge a price above zero. If so, P > MC thus resulting in allocative inefficiency. Therefore, in a free market, allocative efficiency cannot be achieved due to non-rivalry of street lights. Overall, given that street light is a good that has net benefits to the society but it will not be provided in a free market, there will be complete