Public Goods
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The various goods in the economy can be grouped according to two characteristics, which are excludability and rivalry in consumption (Mankiw, 2007). Excludability is the property of a good whereby a person can be prevented from using it (Mankiw, 2007). Rivalry in consumption is the property of a good whereby one persons use diminishes other peoples use (Mankiw, 2007).
Public goods are non-excludable and non-rival in consumption (Colander, 2004). Examples of public goods are street lights and road signs. Common resources are non-excludable but rival in consumption (Mankiw, 2007). Examples of common resources are public parks and waiting area in post office.
If one person were to provide a public good, other people would be better off (Mankiw, 2007). They would receive a benefit without paying for it – a positive externality (Mankiw, 2007). If one person uses a common resource, other people are worse off (Mankiw, 2007). They suffer a loss but are not compensated for it – a negative externality (Mankiw, 2007). Because of these effects, private decisions about consumption and production can lead to an inefficient allocation of resources (Mankiw, 2007). In such cases, government intervention can potentially remedy the market failure and raise economic well-being (Mankiw, 2007).
For public goods, there is a free-rider problem (McConnell and Brue, 1999). The free-rider problem is where people receive benefits from a good without contributing to its cost (McConnell and Brue, 1999). The market would fail to provide the efficient outcome because people would have an incentive to be free-riders rather than paying for a good (Mankiw, 2007).
By taking the example of road signs, if a private firm were to supply road signs, the firm will need to receive payment for supplying it through the usual market allocation system. Because road signs are public goods and public goods are not excludable, people will not pay for it. Since the supply of road signs cannot be priced and sold, private firms have no economic incentive to supply it as it would be unprofitable (McConnell and Brue, 1999).
Therefore, government intervention is needed (Mankiw, 2007). If the total benefits of a public good exceed the total costs, the government will provide the public good by funding it with tax revenue to make everyone better off (Mankiw, 2007).
For common resources, there is this problem called the Tragedy of the Commons (Mankiw,