Every other market failure in this topic is about the market producing the wrong amount of something. Public goods are stranger than that. Here the market produces nothing at all, even though the good is genuinely valuable and everybody wants it. Working out why is one of the neatest bits of reasoning in the whole course.
📘 What you need to know
A public good is non-excludable and non-rivalrous. Both, not one or the other.
Non-excludable means the price mechanism cannot keep non-payers out.
Non-rivalrous means one person using it does not reduce what is left for anyone else.
Because of this, the free rider problem appears: people can enjoy the good without paying, so eventually nobody pays.
Private firms cannot make a profit, so public goods are not provided at all by a free market, which is why governments provide them.
Governments have three responses: do nothing, provide it directly, or contract it out to a private firm and pay for it.
They are usually free at the point of use and paid for through general taxation, and every funding decision carries an opportunity cost.
Two tests, and both must fail
Start with an ordinary private good, like a sandwich. A shop can refuse to hand it over until you pay, so it is excludable. Once you eat it, nobody else can, so it is rivalrous. Those two features are what make it possible to run a business selling sandwiches at all.
A public good fails both tests.
Both answers must be no. Something excludable but non-rivalrous, like a cinema screening, is a club good, not a public good, because the owner can still sell tickets.
The standard examples are street lighting, national defence, flood defences, lighthouses and public parks. Take street lighting and test it properly. Can the company keep out anyone who did not pay? No, the light falls on the whole street. Does your walking under the lamp leave less light for the next person? No, the lamp shines exactly as brightly. Two no answers, so it is a public good.
Test both properties every time, out loud if you have to. Students see “the government provides it” and assume public good. Healthcare is provided by the government in many countries, but it is excludable and it is rivalrous, because a doctor treating you cannot treat someone else at the same moment. That makes it a merit good, not a public good.
The free rider problem
Now follow what happens if a private firm tries to make money from a public good.
Nobody in this chain is doing anything unreasonable. If you cannot be stopped from using something, paying for it is a choice, and eventually people stop making it.
A free rider is someone who consumes a good without paying for it, because they cannot be excluded. The problem is not that free riders are dishonest. It is that free riding is the sensible thing to do, and once a few people notice, the paying customers work it out too. Revenue collapses, the firm makes a loss, and it stops.
Two conclusions follow, and it matters which one you write:
Public goods are not provided at all by a free market. This is stronger than under-provision, and it is what makes public goods different from merit goods.
The resources that should have gone into producing them go somewhere else instead, so society ends up with less than it wants of something everybody values. That is an under-allocation of resources and a clear market failure.
Why there is no supply and demand diagram here. You cannot draw a market demand curve for a good nobody will reveal a willingness to pay for. Everyone has an incentive to say the good is worth nothing to them, hoping someone else pays. So this section is explained in words and definitions, not with a diagram, and that is expected.
What governments can do
There are three possible responses to the under-provision of a public good, and a good answer names all three, including the first.
🧩 The three government options
Do nothing. The good simply is not provided. This is a real choice, and it is what happens when a government judges the cost too high or has other priorities.
Provide it directly. The government builds and runs it: the sea wall, the street lights, the public park, the armed forces. Funded from general taxation and free at the point of use.
Contract it out. The government invites private firms to bid, picks a bid, and pays that firm to provide the good. The government still pays; the firm still makes a profit; the public still uses it for free.
Options two and three both mean public money is spent, so both raise the same question. Every dollar spent on flood defences is a dollar not spent on a hospital ward. That is the opportunity cost of the decision, and mentioning it is the easiest evaluation mark in this section.
Government provision: advantages
Government provision: disadvantages
Valuable goods get provided that otherwise would not exist at all
Funded through general taxation, so people who barely use it still pay for it
Free at the point of use, so access does not depend on income
There is an opportunity cost, and the money may have done more good elsewhere
Delivers both private benefits to users and external benefits to society
Free goods can be over-used, producing shortages and queues
Improves equity, since everybody gets the same standard of provision
Without competition or profit pressure, provision can become inefficient or wasteful
Public goods are not merit goods
This is the distinction examiners test most often in this sub-topic, so learn the table rather than the vibe.
Question
Public good
Merit good
Can non-payers be excluded?
No
Yes
Does one person’s use reduce what is left?
No
Yes
How much does the free market provide?
None at all
Some, but less than the optimum
Why does the market get it wrong?
Free riding makes it unprofitable
Consumers undervalue the benefits, or cannot afford it
Typical government response
Provide it directly or contract it out
Subsidise, provide, or run education campaigns
Example
Street lighting, national defence
Education, vaccinations, dental care
WORKED EXAMPLE
A coastal town needs a sea wall costing $6 million. It would protect 12,000 homes. A private firm proposes charging each household $500. Explain why the firm is unlikely to build it. [4]
Step 1: check the arithmetic first12,000 × $500 = $6,000,000On paper it covers the cost exactly, so this is not a problem of the good being too expensive.Step 2: is it excludable?
No. The wall protects the whole coastline, so a household that refuses to pay is protected anyway.
Step 3: is it rivalrous?
No. One household being protected does not reduce the protection anyone else gets.
Step 4: apply the free rider problemHouseholds realise they gain either way, so they refuse to pay. Revenue falls far below $6m.The firm cannot cover its costs, so the wall is never built without governmentThe town wants the wall and can afford it. The market still fails, because there is no way to collect the money.
WORKED EXAMPLE
Classify each of the following and justify your answer: a public firework display, a toll motorway, a mackerel stock in international waters. [3]
Firework displayAnyone nearby can watch, and one more viewer does not dim it.Non-excludable and non-rivalrous, so a public goodToll motorwayThe barrier keeps non-payers out, and when it is quiet one more car does not slow anyone down.Excludable and non-rivalrous, so a club goodMackerel stockNo country owns the open ocean, and every fish caught is one fewer left.Non-excludable and rivalrous, so a common pool resourceAlways answer both questions before you name the good. The pair of answers gives you the category.
💡 Exam tip
Define with both words. Non-excludable and non-rivalrous. A definition with only one of them will not score full marks.
Say “not provided”, not “under-provided”. For public goods the free market supplies nothing, and that precision matters.
Explain free riding as a chain. Cannot exclude, so people do not pay, so revenue falls, so the firm exits, so nothing is provided.
Do not force a diagram. Explain in words. If you need a diagram, use the goods classification grid rather than inventing a supply and demand curve.
Always name the opportunity cost. Government provision is funded from taxation and that money had alternative uses.
Have three clean examples ready and be able to justify each one against both tests, not just name it.
⚠️ Common mix-up
“The government provides it, so it is a public good.” No. Apply the two tests. Healthcare and schools fail both and are merit goods.
Confusing public goods with common pool resources. Both are non-excludable. Only the common pool resource can be used up.
Thinking public goods are free to produce. They are free to use. Somebody still pays for building them, and that somebody is the taxpayer.
Saying free riders are cheating. They are responding to the incentives. There is no rule to break, which is the whole difficulty.
Forgetting the “do nothing” option. It is one of the three responses and it is worth a mark when a question asks for all of them.
Calling a crowded park non-rivalrous. Once congestion sets in, one more person genuinely does reduce everyone else’s enjoyment, and the good stops behaving like a pure public good.
That is the whole of market failure. Before you move on, test yourself by drawing all four externality diagrams from memory in five minutes, then writing one sentence under each saying which curve split and why. If you can do that, you are ready for any question in this sub-topic.
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