Answer to Question #233718 in Management for Diane

Question

A) What are public goods and why are they considered a market failure? B) Describe and explain which instrument(s) of government can be used to tackle such an issue and how? C) Describe and explain to which basic function of the government can intervention be related to/justified by.

Answer 1

Definition of Public goods

Public goods are commodities or services that benefit all members of society, and which are often provided for free through public taxation. The producer cannot limit its consumption to paying customers and for which the consumption by one individual does not limit consumption by others.

Public goods as a market failure

Public goods create market failures if some consumers decide not to pay but use the good anyway. National defense is one such public good because each citizen receives similar benefits regardless of how much they pay. It is very difficult to privately produce the optimal amount of national defense. Since governments cannot use a competitive price system to determine the correct level of national defense, they also face major difficulty producing the optimal amount. This may be an example of a market failure with no pure solution.

Instruments of government intervention

Market failures can be corrected through government intervention, such as new laws or taxes, tariffs, subsidies, and trade restrictions. Governments can enact legislation as a response to market failure. For example, if businesses hire too few teenagers or low skilled workers after a minimum wage increase, the government can create exceptions for younger or less-skilled workers. Radio broadcasts elegantly solved the non-excludable problem by packaging periodic paid advertisements with the free broadcast. 

Governments can also impose taxes and subsidies as possible solutions. Subsidies can help encourage behavior that can result in positive externalities. Meanwhile, taxation can help cut down negative behavior. For example, placing a tax on tobacco can increase the cost of consumption, therefore making it more expensive for people to smoke.

 Intervention to achieve economic objectives is justified when markets fail to use resources in the most productive way possible. This may be due to the presence of, for example, public goods, externalities, imperfect information or market power. 

Intervention to achieve equity objectives may be justified to improve the distribution of costs or benefits among different groups according to their income, gender, ethnic group, age, geographical location or disability.