Is public transportation a public good? How about national defense? Knowing the characteristics of public goods will help you understand why private firms excel at producing private goods, but they have little incentive to produce public goods. Rather, if society wants public goods, government must produce them. This episode of The Economic Lowdown defines the characteristics of private and public goods and explains why these characteristics help determine who is best positioned to produce each.
The Federal Reserve Bank of St. Louis presents The Economic Lowdown, Episode 17: Public Goods.
Do you ever stop to think about how you use certain goods in different ways? For example, when you’re at a pizza party, the host orders and pays for a large amount of pizza, so you and your friends eat as much as you’d like without paying a dime. Even if your buddies take the pizza off your plate, you can just grab another slice free of charge.
However, when you go out to dinner at a restaurant, you don’t eat quite as much, do you? First of all, you need to stay within your budget. You can’t order everything on the menu if you have no money, no matter how hungry you are. And if somebody else eats your dinner, you can’t eat it.
While these concepts may seem obvious, they are essential to understanding the distinction between public and private goods.
Let’s pretend it’s your lucky day and you get to buy your dream car. You head to your local dealership and find exactly what you want. You can’t just drive the car off the lot, though. You have to pay the dealer first. If you can’t pay, you can’t have the car. But you can, and you do, and you drive off. Your new car is yours, and it’s a private good. I know that may seem obvious, but “private good” is actually a technical economics term. For a good to be a private good, it must meet two conditions: It must be excludable and rival. When a good is excludable, the supplier of the good can keep nonbuyers from obtaining that good. So, in the case of the car, if you did not pay for it, the dealer would not have given you the keys and ownership title—you would be excluded from owning it.
When a good is rival, one person’s consumption—or use—interferes with another’s ability to consume it. If you drive your new car to the mall on the north side of town, I can’t take it to the movie theater on the south side. The car is “rival.” One person driving it keeps another person from driving it. So, cars are private goods because they are excludable and rival.
In contrast, public goods are not limited in these ways.
For a good to be classified as a public good, it must meet two conditions: It must be non-excludable and nonrival. A good is nonexcludable if the supplier of the good cannot prevent those who don’t pay it from consuming or using it. A good is nonrival if one person’s consumption does not hinder anyone else’s consumption of the good. That is, everyone gets to use it freely. So, I can consume as much of the good as I like and you can consume as much as you like. Even if we wanted to, we couldn’t hog it. Additionally a public good may not necessarily be a physical good that you can hold in your hands. Nonexcludable and nonrival services are also considered “public goods.”
National security is an example of a public good. We all benefit from this government service with hardly a second thought. We pay our taxes to the government, and the government uses part of those funds to defend the country from foreign and domestic threats. National security is nonexcludable because there is no way of withholding protection from those who don’t pay taxes. If a missile were heading for the country, the military would shoot it down to save everyone in its path, regardless of who did and didn’t pay their taxes. National defense is nonrival because one person’s use of it does hinder anyone else’s consumption. For example, as the population grows, more people benefit from national security, but the level of protection for those already benefiting remains the same.
It’s important to note that there are different meanings of the term “public.” The economic definition of “public” differs from the common use of the word “public” in everyday language. For a good to be a public good, it must be nonexcludable and nonrival.
So, for example, public transportation is not a public good. It is excludable, because the transit company won’t give you a ride if you don’t pay the fare. It’s also rival because public transportation has limits. At busy times, a train or bus might have to leave passengers behind because of lack of space. So, public transportation isn’t a public good because it is not nonexcludable and nonrival.
A public pool is another example. While it may or may not be nonexcludable, in that you may or may not have to pay to get in, it is rival. If too many people try to use, it can become overcrowded. Everyone’s level of enjoyment may suffer and some people will be left out. So, a public pool is not a public good.
Now, let’s put you to the test. Fireworks shows are a staple of American celebrations. Are fireworks shows a public good or a private good? Well, it depends on the situation.
In many areas, local governments use tax money to pay for fireworks shows for their citizens. First, such fireworks display are nonexcludable. It’s just not possible to stop non-taxpayers from enjoying them simply by looking up to the sky. Second, the fireworks remain just as beautiful regardless of how many people are looking at them. That makes them nonrival as well. So, in general, tax-funded fireworks displays are public goods.
In some cases, however, you may have to pay to see a fireworks display. For example, in a large, fenced-in area such as an amusement park, only paying customers at the park have the best views. While you could possibly stand outside the park and watch for free, you likely wouldn’t see everything the show has to offer, especially if your sight line is obstructed by a roller coaster. In this case, the fireworks display is not technically a public good. Although it may possibly be considered nonrival, it is excludable. People must pay for the best views.
Why does the government usually supply public goods instead of private companies?
For starters, the free rider problem. Free riders are the consumers who don’t pay in order to consume the public good. Since public goods are free, most consumers become free riders because they have no incentive to pay the supplier. After all, consumers have a budget, so they won’t likely pay for a good if they can get for free. While there may be people who recognize the importance of a public good and have enough money to donate voluntarily, they form the exception to the rule. In general, people will not pay willingly for a public good.
If a private business supplied a public good, most people would consume the product for free. Since it is nonexcludable and nonrival, consumers can already get the full benefits without paying anything. They won’t likely donate much, if any, of their hard-earned cash. Hence, the company won’t make much money. That’s why private firms won’t produce public goods; there’s no reward. Firms instead spend their time and resources producing private goods because people do have to pay for those, allowing the firm to sell them for a profit.
When a private market fails to produce a good at the level society wants, or doesn’t produce it at all, economists call this a market failure.
Think back to the fireworks example. A business looking to make money would likely not offer a fireworks display if it can’t exclude people from watching it. It needs to make a profit to stay in business. So, the private market fails to provide as many fireworks displays as society wants.
Because the private market is profit-driven, it produces only those goods for which it can hope to earn a profit. That is, it will not produce public goods.
So how do we get public goods? The government steps in. Unlike a private firm, the government has no profit motive. And the government reduces the free rider problem by collecting taxes from consumers to help fund public goods. You could think of it this way: The government simply returns the public’s own money to them in the form of public goods.
Streetlights are another example of public goods. They’re nonexcludable because anyone can use the lighting even if they don’t pay for it, and they’re nonrival because they shine just as brightly regardless of how many people stand or drive under them. While society has a clear need for lighting for motorists and pedestrians, the free rider problem prevents the private market from providing such goods. Private firms don’t provide streetlights because there’s no way to exclude people who don’t pay for them. So, the government provides streetlights and pays for them with taxes.
Each of us benefits from the use of public goods every day—often without even thinking about it. But they are necessary for a well-functioning economy and society in general. So the next time you read about national security, take in a fireworks show, or drive down a well-lit road at night, stop for a second to think about what your life would be missing without public goods.
This podcast was produced by Econ Lowdown. For more information about other economic topics, visit stlouisfed.org.
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