17.7.4 How Demand Manifestation Problems Lead to Supply
Problems
Regulatory and conventional economic analysis of public goods can be applied
rather well to commercial infrastructure. The focus being directed towards the
supply side of the infrastructure market, the basic economic issue is cost recovery
and maintaining incentives to supply. In the analysis, consumers are usually inactive,
and given that the downstream markets are complete, the infrastructure demand
arising from the downstream markets does not play an important role. The supplyside issues are, however, more complex: a complicated, but familiar trade-off arises
from the duel between ex ante and ex post efficiencies. Marginal cost pricing cannot
be sustained from a dynamic efficiency point of view, although appearing attractive
from a static efficiency perspective. This would entail undersupply unless there is
some form of subsidy to cover the fixed cost of production. If such a subsidy is not
available, commercial suppliers will spread the fixed production cost of the infrastructure over to their consumer base.
Market factors, such as, the competitiveness of the infrastructure market and/or
the feasibility of some form of price discrimination, will dictate how commercial
infrastructure access is priced. But, generally, provided that markets are competitive,
market distribution of commercial infrastructure should work rather well. Downstream producers of private goods appreciate demand for infrastructure quite accurately, because consumers recognise the value of those goods and agree to pay for
such benefits (i.e., there are no relevant externalities). Consequently, from the
demand side, there is little justification for government intervention into commercial
infrastructure markets.
The regulatory and conventional economic analysis of public goods explain only
part of the story when applied to public or social infrastructure. There are obscure
dynamic problems originating from the demand side but, nevertheless, affecting
supply-side decisions about the management, design, and development of infrastructure. When these demand-side concerns are considered, there is increased justification for government intervention. Once more, in spite of important differences
between public and social infrastructure, the basic problem for both types relates
to demand manifestation: the market mechanism will not fully consider or provide
the services for the broader set of social benefits that may be attributed to public or
social goods.
The first set of market failure concerns, namely:
(1) shortage and underuse of infrastructure and
(2) a scarcity of infrastructure-dependent public and social goods,
can be explained by a simple comparison of demand curves for commercial and
public social infrastructure. It is useful to remember that infrastructure demand arises
from the output markets. For commercial infrastructure, (see Fig. 17.4), the demand
curve reproduces the users’ willingness to pay and can, therefore, be construed as a
classification of individual uses according to private and social value from left to
490
17 Infrastructure as Public or Private Goods
Problems
Regulatory and conventional economic analysis of public goods can be applied
rather well to commercial infrastructure. The focus being directed towards the
supply side of the infrastructure market, the basic economic issue is cost recovery
and maintaining incentives to supply. In the analysis, consumers are usually inactive,
and given that the downstream markets are complete, the infrastructure demand
arising from the downstream markets does not play an important role. The supplyside issues are, however, more complex: a complicated, but familiar trade-off arises
from the duel between ex ante and ex post efficiencies. Marginal cost pricing cannot
be sustained from a dynamic efficiency point of view, although appearing attractive
from a static efficiency perspective. This would entail undersupply unless there is
some form of subsidy to cover the fixed cost of production. If such a subsidy is not
available, commercial suppliers will spread the fixed production cost of the infrastructure over to their consumer base.
Market factors, such as, the competitiveness of the infrastructure market and/or
the feasibility of some form of price discrimination, will dictate how commercial
infrastructure access is priced. But, generally, provided that markets are competitive,
market distribution of commercial infrastructure should work rather well. Downstream producers of private goods appreciate demand for infrastructure quite accurately, because consumers recognise the value of those goods and agree to pay for
such benefits (i.e., there are no relevant externalities). Consequently, from the
demand side, there is little justification for government intervention into commercial
infrastructure markets.
The regulatory and conventional economic analysis of public goods explain only
part of the story when applied to public or social infrastructure. There are obscure
dynamic problems originating from the demand side but, nevertheless, affecting
supply-side decisions about the management, design, and development of infrastructure. When these demand-side concerns are considered, there is increased justification for government intervention. Once more, in spite of important differences
between public and social infrastructure, the basic problem for both types relates
to demand manifestation: the market mechanism will not fully consider or provide
the services for the broader set of social benefits that may be attributed to public or
social goods.
The first set of market failure concerns, namely:
(1) shortage and underuse of infrastructure and
(2) a scarcity of infrastructure-dependent public and social goods,
can be explained by a simple comparison of demand curves for commercial and
public social infrastructure. It is useful to remember that infrastructure demand arises
from the output markets. For commercial infrastructure, (see Fig. 17.4), the demand
curve reproduces the users’ willingness to pay and can, therefore, be construed as a
classification of individual uses according to private and social value from left to
490
17 Infrastructure as Public or Private Goods