JC Economics Essay Series #30 – Public Goods & Externality

JC Economics Public Goods & Externality Essay Model Answers 

A typical question on Public Goods (national defence) and Externality (either education or congestion), regarding market failure, divergences between private and social benefits / costs are commonly tested in essay exam Paper 2, be it for positive or for negative externalities. For this topic of Market Failure, do remember that public goods are essentially an inefficiency issue in consumption, hence we say non-excludable in consumption, and also non-rival in consumption.


(a) Distinguish between a public good and private good and explain under which of these classifications public libraries should be placed. [10]

(b) Discuss if the existence of an externality implies that the good should necessarily be provided by the government. [15]


JC Econs Essay – Public & Private Goods

Suggested Answer:

(a) Command Keyword: Distinguish: to differentiate between public good and private good. 
Public good and private good differ in terms of their characteristics (excludability, rivalry) and whether the good will be provided under market forces.

i) Excludability
Public goods are non-excludable in nature. A producer or seller does not have any feasible means to exclude non-payers from benefiting from the good once the good is provided. As a result, the consumers eventually do not want to pay as the issue of free ridership will arise. For example, once the streetlight is on, even those who do not pay will enjoy the light from the streetlights. On the other hand, private goods are excludable in nature. This means that a producer or seller has feasible means to exclude non-payers from benefiting from the good. For example, the seller of a car is able to exclude the consumer from the benefits of owning a car if he/she does not make any payment to purchase the car.


ii) Rivalry
Public goods are non-rivalry in nature because the use by one person does not diminish the benefit to the next person consuming the good. As a result, there is no rivalry in consumption. Hence, there is no additional opportunity cost for the second and third person to use the good. However, private goods are rivalrous in nature because they are exhaustible as there is an opportunity cost involved on every additional unit consumed because consumers have to compete for them. As one consumer consumes one unit of the private good, there is 1 unit lesser of the good left for the next consumer.


Provision under market forces
Public goods will not be provided under market forces. As there are no feasible means to exclude non-payers from benefiting from good once it has been provided, there will be no consumers demanding the good as there will be issues of free ridership arising. to produce the good as they do not have any profit gains. Thus, there will be a missing market and the government will have to intervene to take responsibility and produce the good fully.

Furthermore, producers are not interested to produce the good as the opportunity cost to producing the next unit is 0. Hence, the price of the good will be P= MC = 0 and there is no incentive for private producers

However, private goods will be provided under market forces. There is a market for private goods by the private sector due its excludability and rivalry nature and it means that a profit maximising price can be charged by the firms to the consumers. Hence the private sector will be motivated to undertake the production of private goods.


Context: good /service provided by the public libraries:
The service provided by public libraries is excludable as it is possible to impose the requirement of a membership fee to exclude and prevent non-members from enjoying the services of the libraries if they do not pay.

The service provided by public libraries is also rival in consumption as an additional consumer in the library will make the area more crowded and hence less conducive (reducing the benefit) to read or study. Also, if one consumer borrows a book from the library, there are less books left to be borrowed by the other consumers. Therefore, the public libraries exhibiting both excludability and rivalry are classified as a private good.



JC Econs Essay – Externality & Government Intervention

Define externalities: It refer to the spill over effect of production or consumption which falls onto members of society other than the producers or consumers of the good for which no compensation is made. Externality → Positive & Negative Externality

(Note: Government provision can mean both full provision or partial provision}

Thesis 1: Merit goods that generate positive externalities should be provided (partially) by the government. In the case of positive externalities, there would be a case of under-production or under-consumption of goods because entrepreneurs would consider only private benefits. Let us consider the case of private education which is a merit good that generates positive externalities:
(Illustrate with suitable diagram: see relevant example here


For the individual consumer, he will consume where MPB-MPC. However education has long term benefits to society such as raising the productivity of an economy which the consumer does not take into account. However the socially optimal level is where MSB + MSC. At private market equilibrium , the MSB > MSC. One extra unit of out gives more to society’s benefits than to society’s costs. Therefore the price mechanism under allocates resources to the consumption of education. There is underconsumption of education that generates positive externalities, and hence a welfare loss to society occurs. The shaded area shows the total welfare loss to the society as a result of under allocation of their resources. An underconsumption of education will also result in under-provision of education services.


Government should intervene to correct market failure by providing for the good directly (government provision)

To make up for the difference, the government can choose to intervene through direct provision (partial) to help raise the quantity of education services to the social optimum output level. The government could provide education services (e.g. in Singapore, the Ministry of Education provides the shortfall of education through its national schools.) The rationale for this government action taken is because education is a merit good which they perceive to be intrinsically desirable to the consumers but yet under consumed and hence underproduced by the private sector.


Thesis 2: Public Goods that generate positive externalities should be fully provided by the government (optional). Public goods are non-excludable & non-rivalry, hence this will lead to a missing market as explained in port (a). However, public goods exhibit positive externalities to the society. For example-street lightings and national defence classified as public goods are important to the nation. Streetlighting ensure safety driving on the road for all road drivers and national defence ensures that the country is well guarded and deters any possibility of potential war. Both goods are beneficial to the society as a whole but will not be demanded by the Individual consumers or provided by private producers due to its characteristics of being a public good. Government will need to intervene to provide for these goods fully to maximise the overall welfare to the society.


Anti-Thesis 1: Some goods that generate positive externalities need NOT be provided by the government in the case of certain private goods which generate positive externalities (for example perfume), the government does not step in to provide for this type of good. To the government, perfume is not seen as a good which is intrinsically desirable to the consumers and hence will leave the provision of the perfume to the private producers instead. In general, some externalities simply do NOT justify Gov intervention.


AT2: Goods which generate negative externalities are NOT provided by the government. In the case of a factory discharging chemical waste which generates negative externalities that pollutes the river and kills the fishes, government provision is not even an option as there is already a case of overproduction and government provision will only worsen the matter. Instead, government should be imposing other forms of government intervention to correct market failure of this sort. The same reasoning applies to demerit goods which generate negative externalities.
(Actually, this point is rather weak, it is too obvious, not a strong point.)


AT3: There are other methods to correct the market failure caused by an externality other than through government provision. For eg. use of subsidies to correct positive externalities in the case of education mentioned above. The government could use subsidies, which aim to reduce the cost of consumption of its people. This provides incentive for people to consume the good as it internalises the positive externality achieved. Gov could subsidize schools to a large extent. For example, students in S’pore attending Government public schools pay only up to a small amount a month to enjoy education. These measures are effective in increasing the consumption as shown in the diagram above, where subsidies per unit = MEB. in which it internalises the external benefits and increase consumption to the socially and efficient level. This overcomes the market failure. However, increasing government expenditure due to providing subsidies may cause the government to tap into the government’s budget, which results in increased taxation. This may result in disincentives on work and investment, causing an adverse impact on economic growth. Furthermore, G policies may result in greater degree of inequity (or income inequality).


Tradable pollution permit to correct negative externalities in the case of factory discharging chemical waste mentioned above. For eg, in the case of a factory discharging chemical waste, tradable pollution permits can be used to correct the negative externalities which lead to market failure. The government sets the total allowable level of pollution which it deems desirable and issues permits. If the firm produces less than the amount of permits it has, the firm gets a credit, which can be sold to another firm, allowing it to exceed its original limit.


Trading permits have the advantages of certainty in outcome as there are only a fixed amount of permits being released. In addition, by allowing companies to sell their permits, there is incentive for companies to reduce emissions to below the level allowed by their permits as they can sell their permits for money. However, there are high administrative costs incurred due to the complexity of the system as well as possible scenarios of companies in a certain geographical area buying up all the permits and polluting. leading to concentration of pollution in one small region.


Conclusion (stand)
Hence, it is not necessary for goods which generate externalities to be provided by the government. In the case of the public goods, the government must intervene to provide for the good fully public goods generates substantial positive externalities to the society as a whole but no private producers are willing to provide for the good. In the case of merit goods generating positive externalities, the government could consider providing the good partially to achieve the social optimal output for the consumers in the country. However, the government could also choose to intervene through alternative methods such as subsidies to correct the underconsumption problem.


Despite the limitations which come along with the other alternatives, it is still more feasible and rational at times for the government to subsidize / tax the goods which generate externalities as it can be costly for the government to provide for the goods whenever an externality arises. It can be inefficient for the government to channel their resources to the provision of a good where the use of their resources can be better utilized to improve the other sectors in the economy. At times, the government may even fail to provide for the good efficiently (e.g. due to information lag) and it could be better for the government to leave the allocation of the goods to the free market with minimal government intervention.


JC Econs Tuition Teacher’s Comments:
1. Which of the anti-thesis is strong and which is a weak point?
2. Is the evaluation strong enough? How to ensure you can get E2 marks?
3. Is it a good idea to provide limitations to the alternate methods of intervention to achieve microeconomics objectives?
4. The conclusion can add on the possibility of Government Failure.


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Links: Essay #29 | Essay #31