Introduction

In the last chapter we looked at market failures created by externalities. A good creates a consumption-based external effect, or an externality, when person i's consumption of it has a direct effect – an effect that is not reflected in the market price – on someone else, person j. When externalities are present, the market fails to give us efficiency or Pareto optimality. This is because person i, considering only the market prices he must pay for it, fails to account for the cost (or the benefit) imposed on person j by i's consumption of the good.

In this chapter, we look at market failures created by public goods. A public good is a good that is nonexclusive in use. That is, if it is there and available for use by one consumer, then it is there and available for use by all consumers. In a sense, these are goods that create super-externalities. For example, a judicial system is a public good. If the laws, courts, and police are in place to protect person i, they are there to protect person j as well. (Obviously a public good may be valued differently by the different people; i might be a shopper, happy to have the police around to protect her, and j might be a thief!)

A nonpublic good is sometimes called a private good. A pair of socks is a private good. If i is wearing a pair of socks, then j is not wearing that pair of socks.