Chapter 14 - Market Failure and the Role of the Government

Environmental standards became widely used in the 1960s and 1970s, and they were a huge success. Even though the population has risen by a third and the economy has more than doubled since the United States approved the Clean Air Act in 1970, air pollution emissions have decreased by more than a third.

Despite these achievements, economists argue that there are more efficient ways to deal with pollution than environmental regulations when authorities can directly regulate a polluter's emissions. Society may attain a cleaner environment at a cheaper cost by employing approaches based on economic analysis.

Most existing environmental regulations are rigid, making it impossible to accomplish emission reductions at the lowest feasible cost. For example, even though the costs of reaching that goal are significantly different, two power plants—plant A and plant B—might be commanded to cut emissions by the same proportion.

One approach to deal directly with pollution is to levy an emissions fee on polluters. Emissions taxes are levies based on how much pollution a company creates. Power stations, for example, might be fined $200 for every ton of sulfur dioxide released.

These two traits are not shared by all commodities. Some commodities are nonexcludable, which means that the supplier can't stop people from using them even if they don't pay for them.

One example is fire protection: a fire service that puts out flames before they spread protects the whole city, not just those who have donated to the Firemen's Benevolent Association.

Another benefit is a cleaner environment: pollution cannot be eliminated for certain river users while the river remains polluted for others. In terms of consumption, not all products are equal. If more than one individual can eat the same unit of an item at the same time, the good is nonrival in consumption.

The forces of self-interest alone do not lead to an efficient level of production for a non-excludable good because of the free-rider dilemma. Even if more production of the goodwill benefits consumers, no single person is ready to pay for it, thus no manufacturer is willing to offer it. As a result, in a market economy, nonexcludable commodities suffer from inefficiently low production. In fact, given the free-rider dilemma, self-interest may not even assure that any amount of the item is produced, much alone the efficient quantity.

Pay-per-view movies, for example, suffer from a distinct type of inefficiency since they are excludable and nonrival in consumption. It is conceivable to make a profit by restricting access to those who pay as long as a good is excludable. As a result, producers are eager to provide an exclusive good.

Nevertheless, because pay-per-view movies are nonrival in consumption, the marginal cost of allowing an extra viewer to watch one is zero. As a result, the consumer's efficient price is likewise zero—or, to put it another way, consumers should watch TV movies until their marginal benefit is zero.

Although private commodities are excludable, producers can charge a premium for them, incentivizing them to be produced. Consumers are more efficient paying a positive price—a price equal to the marginal cost of production—because they are also competitors in consumption.

A market economy will lack the incentives to produce efficient amounts of the good if one or both of these qualities are missing.

However, there are some essential products that do not fulfill these criteria, and in these situations, the government can help.

The term A public good refers to the exact opposite of a private good: it is both nonexcludable and nonrival in consumption