Summary of Public Economics: Core Concepts

Public Economics: Core Concepts - Guide for Students

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Introduction

Public Economics — Markets & Externalities examines how markets allocate resources when some goods or activities affect third parties, and how government can correct resulting inefficiencies. This material covers public goods, mixed and merit goods, externalities (production and consumption), policy responses, global public goods, and regulation of imperfect competition.

Definition: A public good is non-rival andnon-excludable; a mixed good has characteristics of both private and public goods; a merit good is considered socially desirable and politically difficult to exclude from beneficiaries.

1. Public goods: Who should provide them?

Core problem

Markets underprovide public goods because users cannot be charged through standard prices; this creates the free-rider problem.
Governments can enforce payments using taxation (coercive power) and therefore finance provision.

Definition: The free-rider problem occurs when individuals can obtain benefits from a good without paying, reducing private incentives to supply it.

Production vs financing

Governments can either produce public goods directly or finance their private provision (e.g., subsidies or contracting).
Example: Roads built by private firms but financed through fuel taxes or vehicle levies.

💡 Věděli jste?Did you know that many goods are privately produced but publicly financed (e.g., private hospitals receiving public funding)?

2. Mixed goods and merit goods

Mixed goods

Have attributes of both private and public goods.
Two common categories:
- Non-rival, excludable (e.g., toll roads, subscription television). The marginal cost (MC) of an extra user may be near zero, yet producers exclude users to charge prices, causing market failure.
- Rival, non-excludable (e.g., congested city roads). Rivalry plus non-excludability creates congestion and inefficient overuse.

Definition: A mixed good is partially rival or partially excludable so that neither pure market nor pure public provision works perfectly.

Merit goods

Goods for which competitive pricing could work, but society decides exclusion would be politically or ethically inappropriate (e.g., basic education, essential health services).
Governments often provide or finance these to ensure broad access.

💡 Věděli jste?Fun fact: Many countries subsidise childhood vaccinations not only for individual health but because of the strong positive externalities they produce at the population level.

3. Externalities — Basics

An externality is when an economic activity imposes costs or benefits on third parties that are not reflected in market prices.
Positive externality: action confers a benefit to others (e.g., beekeeper pollination benefits nearby orchards).
Negative externality: action imposes a cost on others (e.g., pollution from a factory).

Definition: Internalising an externality means adjusting incentives (e.g., taxes, subsidies, regulation) so private decisions reflect social costs or benefits.

Types and notation (supply-side and demand-side)

Demand-side (consumption externalities):
- Positive: $\text{MEB} > 0$, $\text{MSB} > \text{MPB}$
- Negative: $\text{MEB} < 0$, $\text{MSB} < \text{MPB}$
Supply-side (production externalities):
- Negative: $\text{MEC} > 0$, $\text{MSC} > \text{MPC}$
- Positive: $\text{MEC} < 0$, $\text{MSC} < \text{MPC}$

Definition: MPC is marginal private cost; MSC is marginal social cost; MPB is marginal private benefit; MSB is marginal social benefit; MEC is marginal external cost; MEB is marginal external benefit.

4. Negative production externality (example)

Example: Coal mine polluting the air.
Private supply is at MPC; pollution raises social cost to MSC with $\text{MSC} > \text{MPC}$ and $\text{MEC} > 0$.
Market equilibrium based on MPC leads to overproduction $Q_{market} > Q_{social}$ and underpricing relative to the social cost.

💡 Věděli jste?Did you know that coal-fired power plants hi

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Public Economics — Externalities

Klíčové pojmy: Public goods are non-rival and non-excludable leading to free-rider problems, Governments can finance or provide public goods using taxation to internalise provision, Mixed goods combine excludability or rivalry and create market failures (e.g., toll roads, congested roads), Merit goods are politically sensitive to exclude (e.g., basic education, essential health services), Negative production externality: MSC > MPC and market overproduces relative to social optimum, Positive consumption externality: MSB > MPB and market underprovides relative to social optimum, Pigouvian taxes/subsidies internalise externalities but require accurate information on magnitudes, Regulatory options: command-and-control, cap-and-trade, price caps, and rate-of-return each have specific trade-offs

## Introduction Public Economics — Markets & Externalities examines how markets allocate resources when some goods or activities affect third parties, and how government can correct resulting inefficiencies. This material covers public goods, mixed and merit goods, externalities (production and consumption), policy responses, global public goods, and regulation of imperfect competition. > **Definition:** A public good is non-rival andnon-excludable; a mixed good has characteristics of both private and public goods; a merit good is considered socially desirable and politically difficult to exclude from beneficiaries. ## 1. Public goods: Who should provide them? ### Core problem - Markets underprovide public goods because users cannot be charged through standard prices; this creates the **free-rider problem**. - Governments can enforce payments using taxation (coercive power) and therefore finance provision. > **Definition:** The free-rider problem occurs when individuals can obtain benefits from a good without paying, reducing private incentives to supply it. ### Production vs financing - Governments can either **produce** public goods directly or **finance** their private provision (e.g., subsidies or contracting). - Example: Roads built by private firms but financed through fuel taxes or vehicle levies. Did you know that many goods are privately produced but publicly financed (e.g., private hospitals receiving public funding)? ## 2. Mixed goods and merit goods ### Mixed goods - Have attributes of both private and public goods. - Two common categories: - Non-rival, excludable (e.g., toll roads, subscription television). The marginal cost (MC) of an extra user may be near zero, yet producers exclude users to charge prices, causing market failure. - Rival, non-excludable (e.g., congested city roads). Rivalry plus non-excludability creates congestion and inefficient overuse. > **Definition:** A mixed good is partially rival or partially excludable so that neither pure market nor pure public provision works perfectly. ### Merit goods - Goods for which competitive pricing could work, but society decides exclusion would be politically or ethically inappropriate (e.g., basic education, essential health services). - Governments often provide or finance these to ensure broad access. Fun fact: Many countries subsidise childhood vaccinations not only for individual health but because of the strong positive externalities they produce at the population level. ## 3. Externalities — Basics - An **externality** is when an economic activity imposes costs or benefits on third parties that are not reflected in market prices. - Positive externality: action confers a benefit to others (e.g., beekeeper pollination benefits nearby orchards). - Negative externality: action imposes a cost on others (e.g., pollution from a factory). > **Definition:** Internalising an externality means adjusting incentives (e.g., taxes, subsidies, regulation) so private decisions reflect social costs or benefits. ### Types and notation (supply-side and demand-side) - Demand-side (consumption externalities): - Positive: $\text{MEB} > 0$, $\text{MSB} > \text{MPB}$ - Negative: $\text{MEB} < 0$, $\text{MSB} < \text{MPB}$ - Supply-side (production externalities): - Negative: $\text{MEC} > 0$, $\text{MSC} > \text{MPC}$ - Positive: $\text{MEC} < 0$, $\text{MSC} < \text{MPC}$ > **Definition:** MPC is marginal private cost; MSC is marginal social cost; MPB is marginal private benefit; MSB is marginal social benefit; MEC is marginal external cost; MEB is marginal external benefit. ## 4. Negative production externality (example) - Example: Coal mine polluting the air. - Private supply is at MPC; pollution raises social cost to MSC with $\text{MSC} > \text{MPC}$ and $\text{MEC} > 0$. - Market equilibrium based on MPC leads to overproduction $Q_{market} > Q_{social}$ and underpricing relative to the social cost. Did you know that coal-fired power plants hi