Category: Economics

occurs when an informed party takes a hidden (unobserved) action that harms the less-informed party.
Group of answer choices
free-riding
transactions costs
adverse selection
moral hazard

Explain and illustrate what constitutes a Public Good and how this creates efficiency loss in markets. Give examples of laws/policies that attempt to rectify the Public Good problem. (10 Marks)
Definition
A public good is a good that is both non‑rivalrous and non‑excludable:
Non‑rivalrous: one person’s consumption does not reduce availability to others (e.g., national defense, a lighthouse).
Non‑excludable: it is costly or impossible to exclude people from consuming it (e.g., street lighting, clean air).
Pure public goods satisfy both properties fully; many real goods are impure (club goods or congestible public goods) with partial excludability or rivalry.
How public goods create efficiency loss in markets
Because consumers can benefit without paying (the free‑rider problem), private firms cannot reliably charge users. As a result:
Private provision tends to be too low or zero compared with the socially optimal level.
The market fails to equate marginal social benefit (MSB) with marginal cost (MC); for public goods the Samuelson condition requires summing individual marginal willingness to pay to set MSB = MC.
Without collective funding, the outcome is inefficient underprovision and deadweight loss relative to the social optimum.
Illustration
Simple numeric example: three residents each value a streetlamp at $10 (private willingness to pay). The lamp costs $20 to install. Social willingness to pay = 3 × $10 = $30 > $20, so socially the lamp should be provided. Individually, each person refuses to pay expecting others to pay, so a private market may supply zero lamps. The result is an efficiency loss (lamp not provided despite net social benefit).
Examples of laws and policies that attempt to rectify the public good problem
Public provision funded by taxation — governments directly supply public goods (national defense, public parks, street lighting).
Compulsory contributions — mandatory taxes or fees that pool resources to finance provision (general taxation, license fees for public broadcasting).
Subsidies and grants — government pays providers or subsidizes production to encourage provision (research grants for basic science).
Regulation and mandates — laws that require behaviour to achieve public‑good outcomes (vaccination mandates to achieve herd immunity, mandatory pollution controls).
Creation of excludability via property or intellectual‑property rights — patents and copyrights make some benefits excludable, encouraging private provision of innovation and creative works.
Market mechanisms to approximate private provision — tradable permits or user charges where feasible (congestion pricing, tolls for roads, spectrum auctions for broadcasting frequencies).
Public–private partnerships and nonprofit provision — combining public funding or guarantees with private delivery to reduce free‑rider problems.
Summary
Public goods lead to market failure because non‑excludability and non‑rivalry cause free‑riding and underprovision. Governments use taxation, regulation, subsidies, property‑rights regimes and other instruments to reach socially optimal provision or approximate it when pure private markets cannot.