No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Thirteen: Market “Failure” and the Role of the Government 311 This concept illustrates the characteristics of a public good (although we’ll outline some flaws with this particular example in a moment). A public good has two essential features. § § Non-excludability : if one person receives the benefit of the good, others will gain benefit as well—they cannot be excluded from the benefit of the good. § § Non-rivalrous in consumption. In other words, my consumption of the good doesn’t affect the quantity available for your consumption. Ordinary goods are both excludable and rivalrous—like a hot dog. I can certainly exclude you from eating my hot dog; and if I eat it, by definition you can’t. This is not so with public goods. Consider national defense. If one person pays for national defense (let’s say Bill Gates), it is impossible for his neighbors not to receive the benefit—they can’t be excluded, because if you protect the borders for Mr. Gates you also protect them for Mr. Jones. And Mr. Gates’ consumption of national defense in no way precludes your consumption of national defense. This means that voluntary cooperation and purchase of the national defense would be very problematic—everyone would try to free-ride while others do it. Let’s think about this a different way. Have you ever worked on a group project where the reward was the same to everyone on the team? It could have been cleaning up the house, washing the car with your brothers and sisters, or a class project in school. Maybe you were the one that slacked off thinking that someone else would pick up the load, or maybe you were the one that really wanted a good grade and didn’t want to let Sam’s poor performance cost you a grade—so you did his work too. In any case, you have likely either seen free-riding in action, or you’ve been a free rider—or perhaps both at different times! Going back to the 2nd Law of Economics—incentives matter—we aren’t too surprised that people respond to the incentive by trying to free-ride off others for goods that are non-excludable and non-rivalrous. Part of the problem with public goods is that it would be very difficult to determine how much each person valued his or her consumption of the good in order to price it accordingly. The transaction costs would be very high to do so, and quite possibly impossible due to strategic behavior on the part of the public. Strategic behavior can occur when participants realize it is not in their interest to reveal their true preferences. Have you ever watched someone bargain over a price? They are definitely engaged in strategic behavior. This gets back to the knowledge problem of the central planner: how would true preferences ever be known to the planner? Because of the high transaction costs, it may be less expensive for the government to simply tax the general public and pay for the service. As was stated before, it does not necessarily follow that because markets have difficulty providing a service (because of free riders), the government can provide the service more efficiently. And the market often finds incentives to overcome free-riding, as we’ll see next. Non-excludability: A good or service is non-excludable if production for one person necessarily makes it available for everyone (such as non-scrambled radio signals). Non-rivalrous: A good or service is non-rivalrous if consumption by one individual does not reduce the amount available for any other potential consumer. Strategic behavior: when individuals have an incentive to hide their true preferences (as in a negotiation) due to competing interests.