What this lesson teaches
I can explain the causes of market failure: public goods, externalities, information failure, immobile factors and market dominance.
Syllabus 9570, 2.3.2(b). Market Failure and its Causes: Markets may fail in terms of; non-provision of public goods due to non-rivalry and non- excludability; non-socially optimal levels of goods and services due to the presence of externalities, information failure (including asymmetric information), immobility of factors of production, and market dominance
Make a guess
Why do private firms not build flood barriers to sell protection to homeowners?
- People protected by the barrier cannot be made to pay.
- Flood barriers are too expensive for any firm to build.
- The government bans private firms from building them.
Show the answer
People protected by the barrier cannot be made to pay.
A flood barrier is non-excludable. Everyone behind it is safe whether they pay or not, so many would free-ride and the firm could not cover its costs.
Public goods are non-excludable and non-rival, so the free market provides too little or none at all.
A pure public good has two features. It is non-excludable: once provided, no one can be stopped from benefiting. It is non-rival: one person's use does not reduce what is left for others.
Because people benefit whether or not they pay, each has an incentive to let others pay. This is the free-rider problem.
So private firms cannot collect enough revenue, and the market provides none, or far too little, of a good that society values. This is a missing market.
Examples in Singapore include national defence, street lighting and flood control such as the Marina Barrage. The government provides them and pays for them with taxes.
Many goods are only partly public. These quasi-public goods are non-rival up to a point and hard, but not impossible, to exclude people from. A road is non-rival when it is empty, but rival in a jam, because each extra car slows everyone else. It is costly to charge for, but not impossible: Singapore has charged drivers on busy roads through Electronic Road Pricing (ERP) since 1998.
Because quasi-public goods can sometimes be charged for, a market may supply some of them, such as toll roads or ticketed parks. It usually supplies too little, because charging is costly and the benefits spread widely. So governments often provide them, and may charge only when crowding makes use rival.
- Non-excludable
- Cannot stop non-payers from benefiting.
- Non-rival
- One person's use does not reduce others'.
- Result
- Free riding; missing market.
- Quasi-public good
- Partly non-rival and partly non-excludable, such as roads: rival when congested, excludable with ERP.
| Good | Excludable? | Rival? | Type |
|---|---|---|---|
| National defence | No | No | Public good |
| Street lighting | No | No | Public good |
| Healthcare | Yes | Yes | Merit good |
| Education | Yes | Yes | Merit good |
Worked example: A flood barrier
A barrier would protect every home in a district from floods.
- Non-excludable: the barrier protects everyone behind it, whether they pay or not.
- Non-rival: protecting one more home does not reduce the protection for others.
- Each household would rather let others pay, so a private firm could not sell it.
- The government builds it and funds it from taxes.
Watch out for this
Anything the government provides is a public good.
Public goods are defined by being non-excludable and non-rival. Government-provided education and healthcare are excludable and rival, so they are not public goods.
Check your understanding
Why won't private firms supply street lighting?
- People can benefit without paying, so firms cannot collect enough revenue to cover costs.
- Street lighting costs too much to build for any firm to make a profit.
- Few people value street lighting, so demand is too low for a firm to cover the cost.
Show the answer
People can benefit without paying, so firms cannot collect enough revenue to cover costs.
Right. Non-excludability creates the free-rider problem.