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Public sector and market in providing public goods

1601 words (6 pages) Essay in Economics

5/12/16 Economics Reference this

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Using examples, discuss whether the market or the public sector is more efficient in providing public goods.

In economics the broadly accepted definition of a ‘public good’ has two conditions. The first is non-excludability i.e. the good cannot be confined to those who have paid for it. The second is non-rivalry in consumption¬†i.e. the consumption of one individual does not reduce the availability of goods to others. By this definition, the very use of the term ‘public good’ implies that such goods are more efficiently provided by the public sector. This is because if they weren’t they would go under-produced (or not produced at all) by the free market, resulting in market failure. The reasoning behind this is simple; rational consumers will not pay for a product that could be consumed for free if purchased by someone else and in turn, producers will not produce a good that consumers are unwilling to pay for. When comparing the efficiencies and capabilities of the two different sectors in providing these goods we must first examine the extent to which those goods provided by the public sector meet the criteria mentioned above. In this essay I will use examples and graphical analysis to investigate the welfare implications of public goods. Furthermore, I intend to scrutinize the eligibility of those goods deemed to be unfit for private production in the UK and see if they really do measure up to the ‘public goods’ criteria.

Undoubtedly some goods must be provided by the public sector. Street lighting would be a prime example as it is difficult if not impossible to exclude people from benefiting from the light they provide. In addition, no individual’s use of the service detracts from that of others. However this is not the only type of public good. Quasi-public goods are goods that are public in essence but do not fully demonstrate the characteristics of non-excludability and non-rivalry. A prime example of this would be the road network. Although it is currently available to everyone, it could be made excludable through a system of electronic road pricing and although there is non-rivalry in consumption, this is only true to an extent as eventually the road will become congested creating rivalry in consumption. Another example would be environmental public goods such as an open public open space. Nobody would provide this on their own but everyone benefits from it being available.

One of the main concerns that come hand in hand with the existence of public goods is an economic phenomenon known as the ‘free rider’ problem which provides us with a key example of market failure where market-like behaviour of individual gain-seeking does not produce an efficient outcome. The problem is that consumers have an incentive not to reveal their true ability and willingness to pay for public goods if they think they will be made to contribute financially for its provision. After all, if the good does become available they would have just as much access to it as anyone else because a pure public good is non excludable. In other words, consumers have an incentive to avoid financially contributing to a public good in proportion to their actual valuation of the good. This is a problem that can be seen everywhere in society. For example, someone who chooses to evade council tax but still receives local authority services could be described as a ‘free rider’. Another example may residents of a community who stand to gain from the refurbishment local amenities but try to avoid payment knowing they can still benefit once the refurbished amenities are installed. For this reason the financing of public goods is usually ‘enforced’ in some manner, such as the compulsory manner of the TV licensing fee. The free rider problem stems from the idea of people as ‘homo economicus’: a person who is completely selfish and rational, basing their decisions solely on the costs and benefits that effect him or her. Public goods provide such a person with an incentive act as a free rider.

Whether or not the public sector is efficient in providing public goods is a difficult question to answer because finding the efficient level of a public good is extremely difficult. First we must find a valuation of consumer’s willingness and ability for a public good which means estimating the individual demand curves for each consumer and aggregating it to obtain the market demand curve (this process is made especially difficult due to the free rider problem we discussed earlier). This gives us a reflection of the social marginal benefit that people places on every extra unit made available. The diagram below considers a non-pure public good where the marginal-cost of supply does rise slightly as output goes up. If the market fails to provide an adequate quantity of the good then there is a loss in social welfare.

A good example of a public good would be the BBC. With traditional analogue broadcasting it is true that television broadcasting is both non-excludable as well as there being non-rivalry in consumption. Of course, now with digital broadcasting non-payers can be excluded from receiving signal and from using set-top boxes. Nonetheless, even when Britain fully switches to digital in a few years time broadcasting services will continue to be completely non-rival and it is that what matters in relation to the services that BBC provides (one person watching BBC has no effect on someone else’s ability to watch it also). At the moment about 23 million people in the UK own a TV licence at a cost of around £150. The BBC will argue that the majority of License owners value the BBC at more than the current licence price, meaning that there is a net gain from the existence of the BBC. Nonetheless others (including myself) will claim that the Private sector is much more efficient at providing broadcasting services. To start with, the licence fee could be seen as a form of regressive taxation. That is, everyone pays the same flat charge and not what they’re willing or necessarily able to pay, or even the extent to which they watch television. Furthermore, now people have switched predominantly to alternative sources of information (through the internet or digital channels for example) the case for a licence fee diminishes. Nonetheless, people are still made to pay the full fee (which is very costly to enforce by the way, about £150 million per anum) simply for owning a TV, even if they have no intention of watching the BBC channels. I would argue that the private sector is much more efficient at providing broadcasting services for the following reasons. With a subscription based system, such as Sky or Virgin Media, consumers can pay for only the programmes and channels they are interested in and can even pay based on the amount of TV they watch, increasing consumer welfare. Furthermore, through the use on screen advertisements, the private sector has proved that broadcasting services can generate significant profits, providing broadcasting firms with an incentive to provide the good despite it conforming to the criteria of a public good.

A public good is provided at an efficient level when the combined marginal rate of substitution (the rate at which a person is willing to exchange a private good for a public one) of all consumers equals the marginal rate of transformation (the quantity of a private good that society has to forgo in order to produce one more unit of a public good). But when should public goods be provided? The Samuelson-mishi condition is a condition for the efficient provision of public goods. It states the efficient production level of a public good to be where the ratio of the marginal social cost of both public and private good production is equal to the ratio is equal to the marginal social benefit of both public and private good production. Therefore, if the production of a public good can be varied on a continual basis, the optimal quantity to produce is the quantity at which the marginal cost of the last unit is equal to the sum of all prices that consumers would be willing to pay for that unit. This equilibrium ensures that the last unit of a public good costs the same amount to produce as the value given to it by all consumers.

A simple example can show how public goods can be provided efficiently by the public sector. Suppose the government is considering making a new park in a community where there are only tow people: individual A and Individual B. Individual A is willing to pay £300 for use of the park and individual B is willing to pay £400 for use of the park. The total value to society of having the park is £700. If the park can be produced at a cost of £600, there is a £100 gain on its production since it provides a service that the community values at £700 for only £600. Nonetheless, due to complexities of accurately finding efficient levels of a public good, it is my opinion that the public sector should only provide ‘pure’ public goods i.e. those goods that strictly adhere to the conditions of non-rivalry and non-excludability. Goods that can be effectively provided by the free market mechanism (TV channels for example) should be as the twin forces of market supply and market demand will be more efficient at determining proper prices and output levels.

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