Public Goods: Causes of market failure and Corrective Measure by Government

Public Goods: Causes of market failure and Corrective Measure by Government

Public Goods:

  • A public good is a special type of good that can be consumed by everyone, regardless of whether they paid for the goods.
  • Public goods are a commodity or service that is provided without profit to all members of a society, either by the government or by a private individual or organization.
  • For example, public goods include street lighting/lighthouse protection, national and domestic security i.e. national defence and police services, public health, flood defence system, public parks and beaches, education, road, etc.

Characteristics of Public goods

  1. Non-rivalry: where the consumption of goods and services by one person, will not prevent others from enjoying it. For example, if one person takes Vitamin D from the sun, it would not reduce the availability of Vitamin D for others, television signal, etc.
  2. Non-excludability: Public goods that cannot exclude a person or group of persons from consuming them who are not willing to pay (taxes). One cannot refuse anyone to consume public goods. For example Roads, Air, etc. For example, a public road allows practically everyone to use it.

Explain the term Market Failure? What are the causes of Market Failure?

Market failure is the economic situation defined by an inefficient distribution of goods and services in the free market.

Causes of Market Failure

  1. Public Goods: A public good is one whose consumption or use by one individual does not reduce the amount available for others. An example of a public good is water which is available to one person and is also available to others without any additional cost.  It is non-excludable if it can be consumed by anyone. It is non-rivalrous if no one has exclusive rights over its consumption. Its benefits can be provided to an additional consumer at zero marginal cost. Thus public goods are both non-excludable and non-rivalrous. Moreover, environmental quality is generally considered as a public good and when it is valued at market price, it leads to market failure.
  2. Externalities: It arises when one person’s actions affect another person’s well-being, and the relevant costs and benefits are not reflected in market prices. A positive externality leads to producing a smaller quantity than is socially desirable. For example, if an entrepreneur stages a fireworks show, people can watch the shows from their windows. Because the entrepreneur cannot charge a fee and the fireworks show may go unproductive. A negative externality arises when one person’s actions harm another. When polluting, factory owners may not consider the costs that pollution imposes on others.
  3. Market Power: When there is only one buyer or seller in the market, that firm can set the price of the product or the quantity supplied. An imperfect competitive market is one, where the assumption of a large no of buyers and sellers does not hold. These types of market organizations include Monopoly, Oligopoly, and Monopolistic Competition. None of these markets are efficient.
  4. Inequality: Market Failure can also be caused by the existence of inequality throughout the economy. The wide difference in income and wealth between different groups in an economy leads to a wide gap in stander of living between wealthy households and poverty. Society may come to the view that too much inequality is unacceptable or undesirable.
  5. Merits Goods: Merits goods are those goods and services that the government feels that people left to themselves will under-consume and which therefore ought to subside or be provided free at the point of use. For Example, Health services, education, work training, etc.
  6. Demerits goods: Consumption of demerits goods will affect consumers. The market may fail to control the manufacture and sale of demerits goods like cigarettes and alcohol.
  7. Unstable Markets: Sometimes markets become highly unstable, and a stable equilibrium may not be established, such as with certain agriculture markets, foreign exchange, and credit markets. Such sudden changes may require intervention.
  8. Incomplete Market: Whenever private markets fail to provide a good or service even though the cost of providing, is less than what individuals are willing to pay, it is called incomplete markets. It is considered a situation where supply is less than demand.
  9. Asymmetric Information: It is a market situation in which one party in a transaction has more information than the other party. This can affect the firm’s strategy. It can lead to market failure.

Discuss the role of the government in correcting market failure.

  • The Government can play an important role to correct market failure and improve economic efficiency. Government intervention is needed in the economy for the following reasons:
  • To improve economic efficiency by correcting market failures.
    To pursue social values of equity by altering market outcomes.
    To pursue other social objectives by provisions of public and merits goods.

The role of government is explained below:

  1. The Functioning of Market Mechanism: Market Mechanism leads to an efficient allocation of resources, i.e. produces as per consumer’s want and does so in the cheapest way. For this, there must be a perfect competition market in the factor and product market. There must not be any restriction to free entry and exit from the market. Government regulation ad measures will be needed to secure the conditions necessary functioning of the market mechanism.
  2. Providing legal framework: In India, regulatory authorities like SEBI provide the legal frameworks. The government can provide the necessary legal structure and ensure their implementation by the firms and other parties in the market. The contractual arrangements and exchange need for market operation.
  3. Correcting Externalities problems: Externalities lead to market failure. This can be corrected by the government by budgetary provisions, subsidies, and taxation. The government can subsidize the production of Positive externalities goods and taxes or regulate on negative externalities goods.
  4. Correcting problems of distribution of Income and Wealth: The government has to work towards redistribution of income from the rich to the poor through welfare programmes and taxation policies.
  5. Provisions of Public Goods and Merits Goods: Public Goods and merits goods are such goods that they cannot be provided through the market. In the case of public goods, there is a free-rider problem, as resulted in the market failure in the provisions of public goods. Thus, the government has to ensure its provisions. In the case of merit goods that are provided by the government for social welfare, such as education. If it is provided by the market people may under consume such goods. Thus they have to provide free by the government.
  6. Securing important social objective: the market system does not necessarily bring high employment, price level stability, poverty eradication, economic development, and desirable growth rate. Government policies are needed to secure these objectives.
  7. Guiding the use of natural resources: The market mechanism cannot bring about the appropriate allocation of natural resources for the present and future. Similarly, the market mechanism may not be able to control the pollution of the environment. Therefore, the consumption of natural resources, pollution control, etc. should be guided by government policies.
  8. Public ownership: Some industries charge unreasonable high prices and earn abnormal or monopoly profits. In that case, the government can Nationalise such an industry and provide goods and services at the desired price. Also, the government may apply rules and regulations to force industries to charge a reasonable price.

public good

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Reference: ML Jhingan, Manan Prakashan

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