17.2.1 The Free-Rider Problem
The citizens of Xtown, like seeing fireworks on New Year’s eve. The 1000 residents,
each estimate watching the fireworks experience at a value of $12, thus totalling
benefits of $12,000. It costs $2000 to produce a fireworks display. It would be
judicious for Xtown to organize fireworks display as the $12,000 benefit exceeds the
$2000 cost. This is called an efficient outcome.
It is difficult, in this case, for the private market to produce an efficient outcome,
because if a local entrepreneur, Mary proposed to organise a fireworks display, very
few (if any) residents would buy tickets to the event as they quickly realize that they
could watch the fireworks even without possessing a ticket. Mary would not be able
to exclude (prevent them) from watching. These persons (in fact, all of them) would
have an incentive, and be able to be free riders. A free rider is a person who
receives the benefit of a good but does not pay for it. Here, therefore the market
would not produce an efficient outcome, as potential customers would have an
incentive to be free riders rather than ticket buyers.
In fact, this market failure is produced by an externality. (see Fig. 17.1 above).
When Mary organises the fireworks display, she offers an external benefit
(positive externality) on the persons watching the display for free. When Mary has
to make a decision on putting up the display or not, she can only count how many
tickets she can sell. She cannot consider external benefits, as she receives no money
for that. Thus although the fireworks display might be socially desirable, she will not
make any profits, let alone, break even. Therefore, Mary would take the, privately
rational, but socially inefficient, decision not to organise the display.
However, there is a solution to this market failure of providing the fireworks
display desired by Xtown residents: The Municipality can pay for the fireworks
event, either from its coffers or by raising everyone’s taxes by $2. The revenue
collected (1000 Â $2 ¼ $2000) can pay for Mary’s production of the fireworks
display. Now, everybody in the town has been able to enjoy the fireworks, though
not for free, but nevertheless (at a discount) through being better off by $10 – the $12
in estimated value from the fireworks minus the $2 tax bill. Although Mary could not
help as a private entrepreneur, she has helped Xtown reach an efficient outcome
through the fireworks being collectively (through the Municipality or publicly)
funded.
Although simplified, this story of Xtown is plausible and realistic. Not only,
many towns pay for fireworks for certain celebrations, but there is a general lesson
about public goods: as the benefits of public goods are not usually excludable, it is
difficult for the private market to supply them due to the free-rider problem, as
explained above. The government, however, has a potential remedy to the problem.
If the government considers (rightly or wrongly) that the total benefits of a given
public good exceed its overall costs, it can organise for the provision of the public
good, pay for it with tax revenue (collected as raised taxes or the normal budget), and
make everyone better off. (see also Chap. 2 Infrastructure and Economic Growth).
Between the extremes, there is a variety of goods and services generally referred
to as impure public goods. A significant subset consists of partially (non)rival
17.2 Public Goods
475
The citizens of Xtown, like seeing fireworks on New Year’s eve. The 1000 residents,
each estimate watching the fireworks experience at a value of $12, thus totalling
benefits of $12,000. It costs $2000 to produce a fireworks display. It would be
judicious for Xtown to organize fireworks display as the $12,000 benefit exceeds the
$2000 cost. This is called an efficient outcome.
It is difficult, in this case, for the private market to produce an efficient outcome,
because if a local entrepreneur, Mary proposed to organise a fireworks display, very
few (if any) residents would buy tickets to the event as they quickly realize that they
could watch the fireworks even without possessing a ticket. Mary would not be able
to exclude (prevent them) from watching. These persons (in fact, all of them) would
have an incentive, and be able to be free riders. A free rider is a person who
receives the benefit of a good but does not pay for it. Here, therefore the market
would not produce an efficient outcome, as potential customers would have an
incentive to be free riders rather than ticket buyers.
In fact, this market failure is produced by an externality. (see Fig. 17.1 above).
When Mary organises the fireworks display, she offers an external benefit
(positive externality) on the persons watching the display for free. When Mary has
to make a decision on putting up the display or not, she can only count how many
tickets she can sell. She cannot consider external benefits, as she receives no money
for that. Thus although the fireworks display might be socially desirable, she will not
make any profits, let alone, break even. Therefore, Mary would take the, privately
rational, but socially inefficient, decision not to organise the display.
However, there is a solution to this market failure of providing the fireworks
display desired by Xtown residents: The Municipality can pay for the fireworks
event, either from its coffers or by raising everyone’s taxes by $2. The revenue
collected (1000 Â $2 ¼ $2000) can pay for Mary’s production of the fireworks
display. Now, everybody in the town has been able to enjoy the fireworks, though
not for free, but nevertheless (at a discount) through being better off by $10 – the $12
in estimated value from the fireworks minus the $2 tax bill. Although Mary could not
help as a private entrepreneur, she has helped Xtown reach an efficient outcome
through the fireworks being collectively (through the Municipality or publicly)
funded.
Although simplified, this story of Xtown is plausible and realistic. Not only,
many towns pay for fireworks for certain celebrations, but there is a general lesson
about public goods: as the benefits of public goods are not usually excludable, it is
difficult for the private market to supply them due to the free-rider problem, as
explained above. The government, however, has a potential remedy to the problem.
If the government considers (rightly or wrongly) that the total benefits of a given
public good exceed its overall costs, it can organise for the provision of the public
good, pay for it with tax revenue (collected as raised taxes or the normal budget), and
make everyone better off. (see also Chap. 2 Infrastructure and Economic Growth).
Between the extremes, there is a variety of goods and services generally referred
to as impure public goods. A significant subset consists of partially (non)rival
17.2 Public Goods
475