Difficulty: Intermediate | Prerequisites: Chapter 10 (Externalities)
Not all goods work well in a market. Some goods (national defence, clean air) cannot be priced or rationed by the market because no one can be excluded from using them. This chapter classifies goods along two dimensions, excludability and rivalry, and explains why public goods tend to be underprovided and common resources tend to be overused. The result is a framework for when government intervention is needed and what form it should take.
Goods are classified by whether people can be excluded from using them and whether one person's use reduces availability to others. Public goods (not excludable, not rival) invite free riding and are typically underprovided without government. Common resources (not excludable, rival) invite overuse, leading to the Tragedy of the Commons. Government can solve both through provision, regulation, or pricing.
Excludability
The property of a good whereby a person can be prevented from using it. An ice cream cone is excludable (you can refuse to sell it). A tornado siren is not (everyone in earshot hears it).
Rivalry in consumption
The property of a good whereby one person's use diminishes other people's ability to use it. An ice cream cone is rival (once eaten, it is gone). A tornado siren is not rival (one person hearing it does not reduce the warning for others).
Private goods
Goods that are both excludable and rival in consumption. Most goods in the economy fall into this category: ice cream, clothing, congested toll roads.
Public goods
Goods that are neither excludable nor rival in consumption. Examples: national defence, tornado sirens, fireworks displays, general knowledge (e.g., a mathematical theorem).
Think of it as: you cannot stop people from using it, and one person's use does not reduce what is available to anyone else.
Common resources
Goods that are rival in consumption but not excludable. Examples: fish in the ocean, clean air, congested non-toll roads.
Think of it as: anyone can use it, but each person's use takes away from what is left for everyone else.
Club goods (natural monopoly goods)
Goods that are excludable but not rival in consumption. Examples: satellite TV, fire protection, uncongested toll roads.
Free rider
A person who receives the benefit of a good but avoids paying for it. Free riding is the central problem with public goods: because no one can be excluded, everyone has an incentive to let others pay.
Tragedy of the Commons
A parable illustrating why common resources are used more than is desirable from society's standpoint. When nobody owns a resource, nobody has an incentive to conserve it.
Cost-benefit analysis
A study that compares the costs and benefits to society of providing a public good. It is the government's tool for deciding which public goods to provide, but it is difficult because there are no market prices to observe.
Goods are classified along two dimensions:
Rival + Excludable = Private good (ice cream, clothing)
Not rival + Excludable = Club good (satellite TV, uncongested toll road)
Rival + Not excludable = Common resource (fish in the ocean, congested non-toll road, clean air)
Not rival + Not excludable = Public good (national defence, tornado siren, fireworks)
Markets work well for private goods. The other three categories all involve some form of market failure.
Because public goods are not excludable, people have an incentive to free ride, enjoying the benefit without contributing to the cost.
Example: a fireworks display costs $1,000. Each of the 500 residents values it at $10, so total benefit is $5,000. The display is socially efficient. But no individual has an incentive to pay, because they will see the fireworks whether they contribute or not.
Result: the private market will not provide the fireworks, even though society would be better off with them.
The government can solve this by taxing everyone $2 and hiring the fireworks company. Each resident gains $8 ($10 value minus $2 tax).
National defence: not excludable (everyone in the country benefits), not rival (one person's protection does not reduce another's). One of the most expensive government expenditures.
Basic research: general knowledge (a new theorem, a scientific discovery) is not excludable and not rival. Firms have an incentive to free ride on others' research, so government funds basic research and grants patents to encourage private R&D.
Fighting poverty: some economists argue that poverty reduction is a public good. Everyone benefits from living in a society with less poverty, but private charity alone underprovides it because of free riding.
The government uses cost-benefit analysis to decide which public goods to provide and in what quantities.
Unlike private goods, there are no market prices for public goods, so estimating benefits is difficult and imprecise.
Example: a traffic light that reduces fatality risk by 0.5 percentage points is worth $50,000 in expected benefit (0.005 x $10 million value of a statistical life). If it costs $10,000, the project should proceed.
Common resources are rival but not excludable, so people use them without paying. Each person's use imposes a negative externality on all other users.
The Tragedy of the Commons: in a medieval town, shared grazing land works well when the population is small. As the population grows, each family adds sheep, reducing the quality of the land for everyone. Eventually the land is destroyed.
The core problem: a property that is owned by everyone is effectively owned by no one. No one bears the consequences of overuse, no one profits from conservation, so quality deteriorates.
Clean air and water: pollution is a negative externality that degrades a common resource. Government remedies include regulations and corrective taxes.
Congested roads: each additional driver slows everyone else down. Tolls (especially congestion pricing during rush hour) and petrol taxes can address this.
Fish and wildlife: anyone can fish the ocean, so fish stocks are depleted. Governments regulate through fishing licences, catch limits, and seasonal restrictions. International cooperation is needed but difficult.
Markets fail for public goods and common resources because property rights are absent or incomplete.
When a good is not excludable, no one can charge for its use, so it is either underprovided (public goods) or overused (common resources).
Government solutions typically work by creating a kind of property right: permits, licences, regulations, or direct provision funded by taxes.
"Public goods and publicly provided goods are the same thing." They are not. A public good is defined by its characteristics (not excludable, not rival). A publicly provided good is anything the government chooses to supply, which could include private goods (e.g., government-provided healthcare is excludable).
"The Tragedy of the Commons means common ownership always fails." It fails when the resource is scarce relative to demand. When land or fish are plentiful, common ownership works fine. The tragedy occurs as pressure on the resource grows.
"Public goods should never be provided because people free ride." The free-rider problem is precisely why government provision is needed. The benefit to society can far exceed the cost, but private markets will not supply the good.
"Club goods are public goods." Club goods are excludable (you can be prevented from using satellite TV if you do not pay), even though they are not rival. This makes them different from true public goods.
⚠️ Know the 2x2 matrix: excludable/not excludable on one axis, rival/not rival on the other. Be able to classify any good into one of the four categories.
⚠️ Understand the free-rider problem and why it leads to underprovision of public goods.
⚠️ Be able to explain the Tragedy of the Commons using the externality framework: each user imposes a negative externality on all other users.
⚠️ Know examples for each category: private goods (ice cream), public goods (national defence), common resources (fish in the ocean), club goods (satellite TV).
⚠️ Cost-benefit analysis: know that it is imprecise because public goods lack market prices.
Fill in the blank: The two characteristics used to classify goods are ______ and ______. (Excludability and rivalry in consumption.)
True or False: Public goods are underprovided in the absence of government. (True.)
Fill in the blank: A person who receives the benefit of a good without paying for it is called a ______. (Free rider.)
True or False: Common resources are overused because they are not excludable. (True.)
Fill in the blank: The Tragedy of the Commons arises because of a ______ externality. (Negative.)
Q: Which categories of goods are excludable?
A: Private goods and club goods.
Q: Which categories of goods are rival in consumption?
A: Private goods and common resources.
Q: The three residents of Smallville are considering a fireworks display. Clark values it at $80, Lana at $50, and Pete at -$30. Fireworks cost $120 ($40 per person). What is the efficient outcome?
A: Not to provide the public good, because total value ($80 + $50 - $30 = $100) is less than the total cost ($120).
Q: Why is national defence considered a public good?
A: It is not excludable (everyone in the country benefits from being defended) and not rival (one person's protection does not reduce the protection available to others).
Q: How does the Tragedy of the Commons relate to externalities?
A: When one person uses a common resource, it imposes a negative externality on all other users by reducing the quality or quantity of the resource available. Because people ignore this externality, the resource is overused.
This chapter is closely linked to Chapter 10 (Externalities): public goods and common resources both involve externalities arising from the absence of a price. The free-rider problem is the consumption-side mirror of the Tragedy of the Commons. Property rights, introduced here, connect to the Coase theorem (Ch. 10) and are fundamental to the broader question of when markets work and when they fail.
Related Terms / Search Tags
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