Why might markets underprovide public goods?

Markets might underprovide public goods due to their non-excludable and non-rivalrous nature, leading to free-rider problems.

Public goods are unique in their characteristics. They are non-excludable, meaning that once they are provided, no one can be excluded from using them, regardless of whether they have paid for them or not. They are also non-rivalrous, meaning that one person's use of the good does not reduce its availability to others. These characteristics create a situation where individuals have no incentive to pay for public goods, leading to what is known as the free-rider problem.

The free-rider problem arises because individuals realise that they can benefit from a public good without paying for it. For example, a person can enjoy the benefits of a clean environment or national defence without contributing to their provision. This leads to a situation where everyone waits for someone else to pay for the public good, resulting in its underprovision by the market.

Furthermore, the provision of public goods is often associated with significant costs. For instance, building infrastructure like roads, bridges, or public parks requires substantial investment. However, because these goods are non-excludable and non-rivalrous, firms cannot charge individuals directly for their use. As a result, they may not be able to recover their costs or make a profit, discouraging them from providing these goods.

In addition, it is difficult for markets to determine the optimal level of provision for public goods. In a typical market, prices serve as signals of demand and supply, helping to allocate resources efficiently. However, because public goods are not sold in markets, there is no price mechanism to indicate their value to society. This makes it challenging for markets to assess how much of a public good should be provided.

In conclusion, the unique characteristics of public goods – their non-excludability and non-rivalry – combined with the free-rider problem, high provision costs, and difficulty in determining optimal provision levels, can lead to their underprovision by markets.