Question

How do you demonstrate your ability to link the basic underlying economic concept of allocating scarce resources to a "real world" application in light of this most "common" market failure?

*Public goods and common resources*

Answer 1

Market failures arise when the voluntary exchange process does achieve the allocative efficiency criterion that the value of goods produced equals the value of goods not produced. Public goods causes inefficiency because non payers cannot be excluded from consumption, which then prevents voluntary market exchanges. Market control occurs because limited competition among buyers or sellers prevents the equality between demand price and supply price. Externalities prevent efficiency because external costs or benefits mean demand price or supply prices do not fully reflect the value of goods produced or the value of goods not produced. Imperfect information among buyers or sellers, like externalities, also means that demand prices or supply prices do not fully reflect the value of goods produced or the value of goods not produced.

While markets do a relatively good job of allocating resources under most circumstances when they fall, the only alternative is some sort of government intervention. Intervention might take the form of direct government provision or production, often done with public goods or intervention might be laws or regulation, a common remedy for market control and imperfect information. Government taxes are another method of intervention that is often recommended for externalities.

Public goods

Public goods are goods that can be consumed simultaneously by a large number of people without the consumption by one imposing an opportunity cost on others, what is termed non rival consumption. They are further characterized by the inability to exclude non payers from consumption. Non rival consumption means that public goods are efficiently allocated if provided at a zero price, something markets are seldom inclined to do. Moreover the inability to exclude non payers gives rise to the free rider problem, which further inhibits the voluntary exchange of public goods through markets.

If markets do attempt the voluntary exchange of public goods, which results in a nonzero market price, then efficiency is not achieved. A nonzero market price means there is no equality between the value of goods produced and the value or opportunity cost, of goods nor produced which is zero due to non rival consumption.

Closely related to public goods are near public goods and common property goods that share one but not both of key characteristics of non rival consumption or the inability non payers.

• Near public goods, like public goods, are non rival in consumption, bu non payers can be excluded. Non rival consumption means efficiency is achieved if near public goods are provided at a zero price which markets don't do.
• Common property goods, like public goods, are characterized by the inability to exclude non payers, but are rival in consumption. Non rival consumption means efficiency is achieved if markets are used for exchange, but such is not possible with the inability to exclude non payers.