Why It Matters: Public Goods and Externalities

Why describe the complications surrounding public goods and externalities in an economy?

Decisions made by firms and individuals in a market often have a spillover effect on other people, whether it be for good (like your neighbor’s sweet-smelling cookies), or for the bad (the smelly paper plant that opened up a mile away). In this module, we learn about these positive and negative externalities, as well as the range of public versus private goods.

One of the characteristics of any good or service is its “public” or “private”-ness. Goods can be public or private, or anything in between. What does this mean? It’s probably not what you think. It doesn’t primarily mean who provides the product. In other words, a good is not private because it is provided by private businesses. A good is not public because it is provided by the government. Rather, private/public is more a description of how these goods are consumed.

Photograph of three flying F-15 Fighters.

Figure 1. National defense is a public good because it benefits everyone in the nation.

All of us consume private goods and public goods. There are three basic cases: A private good is one for which the consumer pays all the costs and receives all the benefits. If you buy an apple to eat, no one gets to share any part of the apple that you eat. A public good is one where one person’s consumption doesn’t prevent anyone else from consuming it too. National defense is the classic example–once it’s there, everyone gets the benefits of it. This leads to “free riding,” where people try to avoid paying for the public good since they’ll get the benefits anyway.

In between public and private goods are externality goods (or semi-public goods). In some cases, benefits go beyond the individuals who consumed the externality good. One example is health expenditures. People in a community at large benefit when others get vaccinated against disease, since people won’t be infected by people who are vaccinated. In other cases, costs are imposed on people other than the ones who produced the externality good. Suppose you go to a park for a picnic, and you bring your iPod and external speakers. You play music during the picnic, which others in the park find objectionable. Your music reduces the quality of other park visitors’ experience.

  • What are some other examples of private goods? (Hint: most of the things you consume are private goods.)
  • What are some other examples of public goods?
  • How can “free riding” be prevented?
  • What are some other examples of externality goods (or externalities in general)?
  • Why does it make sense for society to pay for public education, when not everyone has children?

Public goods and externality goods tend to be either supplied too much or supplied too little compared to what is optimal for society. What policies can government pursue to ameliorate this?

Let’s find out.