Year 12 Economics
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Markets may lead to an efficient allocation of resources. However,
there are some goods and services which economists recognise are
unlikely to be produced in free markets. These may include defence,
the judiciary and the criminal justice system, the police service,
roads, the fire service and education. More controversially, some
believe that the free market is poor at producing health care and
housing for less well off. There are different reasons why there
might be market failure in the production of these goods.
Nearly all goods are PRIVATE GOODS (not to be confused with goods
produced in the private sector of the economy). A private good is one where
consumption by one person results in the good being available for
consumption by another. For example, if you eat a bowl of muesli, then your
friend cant eat it, if a firm builds a plant or a piece of land, that land is not
available for use by local farmers.
A few goods however are public goods or pure public goods. These are
goods which possess two characteristics.
Non-rivalry- consumption of the good by one person does not reduce the
amount available for consumption by another person; sometimes this is
known as non-diminishability or non-exhaustibility
Non-excludability – once provided, no person can be excluded from
benefiting (or indeed suffering in the case of a good like pollution).
There are relatively few examples of pure public goods, although many
goods contain a public good element. Clean air is a public good. If you
breathe in clean air it does not diminish the ability of others to breathe
clean air, moreover, others cannot prevent you from breathing clean air.
Defence is another example. An increase in population of the UK does
not lead to a reduction in the defence protection accorded to the existing
population.
Goods which can be argued to be public goods are
...
 Defence
 The Judiciary and Prison Service
 The Police Service
 Street Lighting
If the provision of public goods were left to the market
mechanism, there would be market failure. This is
because of the free rider problem. A public good is one
where it is impossible to prevent people from receiving
the benefits of the good once it has been provided. So
there is very little incentive for people to pay for
consumption of the good. A free rider is someone who
receives the benefit but allows others to pay for it. For
example, citizens receive benefits from defence
expenditure. But individual citizens could increase
their economic welfare by not paying for it.
In a free market national defence is unlikely to be provided. A firm
attempting to provide defence services would have difficulty charging for
the product since it could not be sold to benefit individual citizens. The
result would be that no one would pay for defence and therefore the
market would not provide it. The only way around this problem is for the
state to provide defence and force everyone to contribute to its cost
through taxation.
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A Merit good is one which is underprovided by the market mechanism (i.e. One
which some people think should be provided in greater quantities).
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One reason for the under provision is that individuals lack perfect information
and find it difficult to make rational decisions when costs occur today but the
benefits received only come in, say, thirty years time. Another reason is
because there are significant positive externalities present.
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Health, education and insurance are the main merit goods provided today by
the government in the UK. Health and insurances are two examples where
consumers find it difficult to make rational choices because of time.
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If left totally to market forces, the evidence suggests that individuals would not
give themselves sufficient health cover, or cover against sickness,
unemployment and old age.
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Young people tend to be healthy and in work. Many find it difficult to appreciate
that one day they will be ill and out of work.
A Demerit Good is one which is overprovided by the market mechanism.
The clearest examples of demerit goods are drugs- everything from hard
drugs such as heroin to alcohol and tobacco. Consumption of these
goods produces large negative externalities.
Crime increases, health costs rise, valuable human economic resources
are destroyed and friends and relatives suffer distress. Moreover
individuals themselves suffer and are unable to stop consuming because
drugs are addictive. Therefore it can be argued that consumers of drugs
are not the nest judges of their own interests.
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Governments intervene to correct this market
failure. They have three main weapons at
their disposal: they can ban consumption as
with hard drugs; they can use the price
system to reduce demand by placing taxes on
drugs; or they can try to persuade consumers
to stop using drugs, for instance through
advertising campaigns
http://www.youtube.com/watch?v=ftkYPpD4K8M
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Direct Provision- Governments can supply public and merit goods
directly to consumers free of charge. In the UK primary school educations,
visits to the doctor and roads are provided in this way. The government
may choose to produce the good or service itself, as with primary school
education, or it may buy in the services of the firms in the private sector.
General Practitioners, for instance work for themselves and the
governments buy their services.
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Subsidised Provision- The government may pay for part of the good or
service (a subsidy) but expect consumers to pay for rest, Prescriptions or
dental care are subsidised in this way in the UK.
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Regulation- The government may leave provision to the private sector but
force consumers to purchase a merit good or producers to buy a merit
good. For instance, motorists are forced to buy car insurance by law.
There is an ongoing debate in industrialised countries whether workers
should be forced to pay into private pensions. Motorway service stations
are forced to provide toilet facilities free of charge to motorists whether or
not they purchase anything.
Government
Intervention
Advantages
Disadvantages
Direct Provision
Government directly controls
the supply of goods and
services- it determines the
number of hospital beds etc.
Maybe inefficient, particularly if the
government produces the good itself.
Wrong mix of goods could be
produced.
May provide too many soldiers and too
few hospital beds for instance.
Subsidies
Can help those on low
incomes to afford to buy
goods.
Decisions about the level of subsidies
can become captured by producers.
Subsidies then become too large to
maximise welfare.
Regulation
Requires little or no taxpayers
money to provide the good.
Regulations can impose heavy costs
on the poor society.
Consumers are also likely to
be able to shop around in the
free market for a product
which gives them good value,
ensuring productive and
allocative efficiency.
Regulations can also be ignored.
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It would be extremely improbable that a free market system would lead to a
distribution of resources which every individual would see as equitable. It is
therefore argued by some economists that the state has a duty to
reallocate resources.
In the UK, for instance, there is some consensus that British Citizens
should not die for lack of food, or be refused medical treatment for lack of
money.
In the UK over 30% of all public spending is devoted to social security
payments. Some of these payments come from the national insurance fund
and therefore could be seen as merit goods. However, benefits such as
family credit are an explicit attempt to redistribute income to those in need.
It could also be argued that free provision of services such as health and
education leads to more equitable distribution of resources.