Chapter 16
Government and Market Failure
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Private goods are rivalous and excludable
Both features must be present
Rivalry means when someone buys and consumes a
good, they prevent anyone else from buying and
consuming that good
Excludability means the seller can exclude non-payers
from enjoying the product
These characteristics are not found for public goods—
their absence makes it impossible for private providers
to profit from offering these products
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Public goods are nonrivalous and nonexcludable
Nonrivalry means that more than one person can
consume the same good at the same time
Watching a ballgame is a nonrivalrous good, though
particular seats in a ballbark are rivalous. Ballgames
are provided privately because they are excludable.
Nonexcludability means that the good’s benefits cannot
be limited to those who pay for it
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If consumers can enjoy satisfaction from a nonrivalous
good, and cannot be excluded from using it even when
they don’t pay….
There’s no incentive to pay for the good if it is offered
on the market,
And there’s no incentive for private agents to offer it for
sale….
So it must be provided by the government or not at all.
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The optimal amount is determined by the collective
willingness to pay, the vertical sum of the prices for a
given quantity (marginal social benefit)
And the intersection with the marginal cost
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Net benefit = marginal benefit – marginal cost
NB = MB – MC
Determines the socially optimal quantity
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aka “spillover” costs and benefits
Negative externalities (external costs) result in a lower
production cost being borne by the producer and being
passed onto consumers
Creates an overallocation of resources—producers
produce too much
Positive externalities (external benefits) result in more
satisfaction being received by consumers than producers
can charge for
Results in underallocation of resources—producers
produce too little
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Market processes can internalize all costs and benefits,
provided
◦ A. Property rights are well understood, enforced, and mutually
agreed on,
◦ B. The number of independent negotiating agents is small, and
◦ C. Transaction costs, including costs of bargaining, are small
enough to be negligible.
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Too many participants or too high transaction costs
make a private solution unworkable.
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Only producers know their marginal costs, and only
consumers know their own marginal benefits
Used car dealers know whether the car is a lemon
Buyers find out later
Results in a market solution that all used cars are worth
significantly less than new cars
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Lojack and other car antitheft devices lower car theft,
even of cars without them
Local crackdowns on chopshops reduce theft
Crackdowns on traffickers in stolen car audio equipment
yield even better benefits