Public Policy: Using Market-Based Approaches - Department for ...

Public Policy: Using Market-Based Approaches
attempt to achieve the same outcome; 12 or they could sell the right to become
the monopolist and capture any monopoly profits for the public purse. 13
PUBLIC GOODS
Public goods have two characteristics which differentiate them from other goods
and services: non-rivalry and non-excludability.
● Non-rival goods or services have a zero marginal cost: the cost of supplying
the good or service does not increase when the number of consumers or the
volume of output they consume increases. An example of a non-rival good is
a terrestrially broadcast television or radio service.
● Non-excludable goods are goods or services where it is not possible to limit
the number of consumers. In particular, suppliers are not able to provide
services only to those who pay for them: other consumers can ‘free-ride’
using the same service even though they have not paid to receive it.
Examples of non-excludable goods include national defence and street
lighting.
A good which is both non-rival and non-excludable might not be provided by the
private sector, or might be provided at a lower quantity than would maximise
social welfare. If the supplier cannot exclude free-riders there is no incentive for
consumers to pay for the service, so the supplier might not be able to earn
sufficient revenues to cover its costs, even when society would value its
provision. The public sector may therefore need to intervene to ensure that such
goods and services are provided in sufficient quantities.
EXTERNALITIES
The consumption of a good or service by one set of individuals can in some
circumstances affect the welfare of others. This effect is called an externality.
Externalities can be positive or negative. An example of a negative externality is
the pollution created from the use of fossil fuels; an example of a positive
externality is the benefit that a homeowner with a carefully tended garden
confers on his neighbours. 14
In the presence of an externality, the welfare society gains from the consumption
of a product is different (higher or lower) than the welfare received by the
suppliers and direct consumers of the product. As a result, the amount that
direct consumers chose to use will not be the same as the level of consumption
12 For a useful introduction to the issues of regulating natural monopolies see Armstrong, M., S. Cowan and J.
Vickers. (1999) Regulatory Reform: Economic Analysis and British Experience, The MIT Press: Cambridge, MA;
and Newbery, D. (1999) Privatisation, Restructuring and Regulation of Network Industries, The MIT Press:
Cambridge, MA.
13 See Demsetz, H. (1968) ‘Why Regulate Utilities?’, Journal of Law and Economics, for the first paper suggesting
that competition for a market with natural monopoly characteristics could result in an efficient outcome.
14 This concept is related to that of public goods in that non-excludable public goods (e.g. street lighting and
policing) create positive externalities.
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