Micro CHAPTER 6.3:

CHAPTER SUMMARY

Free markets frequently lead to socially inefficient outcomes. This can be because producing a certain type of good or service does not really offer a way to make a profit in the private sector (businesses), often because of the free rider problem. This is the idea that there are many goods and services that we cannot stop someone from using, even if they do not pay for it. For example, it would be hard to make a profit building and installing street lights. People certainly benefit from them, but how could you get someone to pay for them?

Because of this problem, the public sector (government) steps in to offer public goods where free markets fail. Generally, for something to be a candidate to be a public good, it should meet two criteria:

1. It is non-exclusionary - this means that anyone can use it, and it is difficult to stop someone from doing so if they don't pay.

2. It is non-rival - this means that one person using it does not affect someone else's ability to also use it. This is also called shared consumption.

Usually, if something meets just one of these characteristics, it could be made in either the public or private sector, and if it meets neither of them, it is best to be produced by the private sector.

So how should the government determine how much of a public good to produce? It looks almost exactly like Chapter 1.5 - the only difference is that, instead of looking for the point where my marginal private benefit equals my marginal private cost (left), they are looking for the point where the marginal social benefit equals marginal social cost.

To pay for these public goods, governments collect taxes to cover the costs of things that benefit society, but would not be produced by free markets.

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