“The best things in life are free. . .” Most goods in our economy are allocated in markets. ä For these goods, prices are the signals that guide the decisions of buyers and sellers. 2 2

“The best things in life are free. . .” When goods are available free of charge, the market forces that normally allocate resources in our economy are absent. 2 3

“The best things in life are free. . .” When a good does not have a price attached to it, private markets cannot ensure that the good is produced and consumed in the proper amounts. 2 4

“The best things in life are free. . .” In such cases, government policy can: potentially remedy the market failure raise economic well-being 2 5

The Other Economic Functions of Government Providing Public Goods Goods to which the principle of rival consumption does not apply In contrast, private goods can be consumed by one individual at a time.

The Other Economic Functions of Government Characteristics of public goods Shared Consumption - additional users of public goods do not deprive other users Non-excludable - difficult to charge for a public good based on consumption—the exclusion principle

The Political Functions of Government Merit Goods Goods deemed socially desirable through the political process Museums Ballet Concerts Theater Provided through subsidization

Example: Parking on a Public Street Some Chicago residents use the “dibs system” to claim a parking space once they have shoveled it out. Does a free parking spot fit the definition of a public good?

The Other Economic Functions of Government Free-Rider Problem Arises when some individuals take advantage of the fact that others will take on the burden of paying for public goods Free-Rider: a person who receives the benefit of a good but avoids paying for it. Question How much national defense did you consume last month?

The Free-Rider Problem Since people cannot be excluded from enjoying the benefits of a public good, individuals may withhold paying for the good hoping that others will pay for it. The free-rider problem prevents private markets from supplying public goods. 11 17

Solution to the Free-Rider Problem The government should provide the good if its total benefits exceed the costs. The government can make everyone better off by providing the good and paying for it with tax revenue. 12 18

Cost-Benefit Analysis In deciding whether to provide a public good or not, one must determine the benefits and costs. 14 20

Cost-Benefit Analysis A cost-benefit analysis would be used to estimate the total costs and benefits of the project to society as a whole. ä It is difficult to do because of the absence of prices needed to estimate social benefits and resource costs. äThe value of life, the consumer’s time, and aesthetics are difficult to assess. 14 21