1. AP MICROECONOMICS UNIT #6 MARKET FAILURE/ ROLE OF GOVERNMENT
Lecture 6
Public vs. Private Goods

2. “The best things in life are free. . .”
Most goods in our economy are allocated in markets…
Market Failure: market forces that normally allocate resources are absent when a good is free of charge…
Government policy can remedy the market failure and raise economic well-being.

3. CATEGORIES OF GOODS Excludability Rivalry
Excludability means sellers can exclude people who do not pay for a good from receiving the benefits
Rivalry
Rivalry occurs when one person’s use of a good makes it unavailable for another’s consumption

4. Four Types of Goods Rival? Yes No Private Goods Natural Monopolies •
Cable TV
Uncongested toll roads •
Ice-cream cones
Clothing
Congested toll roads
Yes
Excludable?
Common Resources
Public Goods •
Fish in the ocean
The environment
Congested nontoll roads •
Tornado siren
National defense
Uncongested nontoll roads No
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5. PRIVATE VS. PUBLIC GOODS
Private Goods
Rival and Excludable
Examples?
Public Goods
Nonrival and Nonexcludable
Create Free-Riders: a person who receives the benefit of a good but avoids paying for it.

6. The Free-Rider Problem
Why should I pay for something if I can’t be excluded from it?
Prevents private markets from supplying public goods.
Solving the Free-Rider Problem
The government can decide to provide the public good if the total benefits exceed the costs.
The government can make everyone better off by providing the public good and paying for it with tax revenue.

7. Optimal Amount of Public Goods
Achieving MB = MC
Government must “estimate” demand since market is not operating
Demand for a public good is the collective willingness to pay for an additional unit
Determined by adding the prices people are willing to pay for the good
Supply curve is MC, so law of diminishing returns applies

8. Optimal Amount of Public Goods
Marginal Cost-Marginal Benefit Analysis
Government should “produce” a good when MB > MC
Take action with maximum net benefit
Economists consider it to be uneconomical or wasteful if the government does not provide when MB > MC

9. Government Allocation
Corrects for market failure called externalities
Cost or benefit taken on by an external party
These 3rd party costs or benefits are also called spillovers
Externalities cause markets to be inefficient, and thus fail to maximize total surplus

10. Negative Externalities
The intersection of the demand curve and the social-cost curve determines the optimal output level
The socially optimal output level is less than the market equilibrium quantity.
Marginal Social Costs > Marginal Private Costs
or MSC > MPC

11. EXTERNALITIES AND MARKET INEFFICIENCY
Negative Externalities
Automobile exhaust
Cigarette smoking
Barking dogs
Loud stereos in an apartment building

12. Negative Externality: Pollution and the Social Optimum
Price of
MSC
Aluminum
Cost of
pollution
Demand
(MPB = MSB)
Supply
(MPC)
Optimum
QOPTIMUM
Equilibrium
QMARKET
Quantity of
Aluminum
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13. Positive Externalities
When an externality benefits the bystanders, a positive externality exists
The social value of the good exceeds the private value.
Marginal Social Benefit > Marginal Private Benefit
or MSB > MPB

14. Positive Externalities
The intersection of the supply curve and the social-value curve determines the optimal output level.
The market produces a smaller quantity than is socially desirable.
The social value of the good exceeds the private value of the good.

15. EXTERNALITIES AND MARKET INEFFICIENCY
Positive Externalities
Immunizations
Restored historic buildings
Research into new technologies

16. Positive Externality: Education and the Social Optimum
Price of
Education
MSB
Supply
(MPC = MSC)
Demand
(MPB)
QOPTIMUM
QMARKET
Quantity of
Education
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