1. Public Goods
The classic case of a public good is national defense. The market failure is inherent in the nature of the benefits. There are two characteristics: (1) the benefits are not diminished by additional users and (2) there are difficulties in excluding those unwilling to pay. Providing national defense requires that we impose taxes which enable the government to organize and produce national defense. Everyone enjoys defense equally, and it would be impossible to ration its benefits.
Private goods, by contrast, require no such intervention. Since benefits are exclusive to the buyers, firms have incentive to produce and sell them for a profit. The market produces and rations them very effectively,
2. Goods with Important Social Benefits
Other goods have both private as well as social benefits. If left to the free market alone, it would only account for the private, excludable benefits and thus would produce a less-than-efficient supply. Consider the case of education. There are definite private benefits to every student and to his or her family. But there are also huge benefits to firms who hire educated workers. Education also complements the “covenant” we discussed as part of our American Dream. A necessary part of providing a wide range of opportunities is to start with proper educational opportunity. There are a multitude of social benefits to society as a whole as we become better educated.
Similarly, health care has both private and public benefits. Individuals and their families benefit directly so that even without public intervention some health care would be provided. How best for the government to intervene is a complicated question and different nations have developed a range of alternatives. Many nations—as well as, I contend, the American Dream—consider health care a basic right. Our government supports health care in many ways to include medical research and education, mental health, and various regulatory agencies. Here, as in every country, there is wide support for national health insurance. Here, until recently, our dysfunctional political system has denied Americans from realizing this basic part of the American Dream. Our difficulty in providing national health insurance is a prime example of our political polarization and our damaged sense of community.
3. Imperfect Competition: Monopoly and Oligopoly
In our utopian model of free market capitalism, “allocative efficiency” is dictated by competition among a large number of firms. In the real world some markets cannot support large numbers of firms, without which competition cannot guarantee efficiency. The term “economies of scale” refers to the market situation where the larger the firm the lower the cost. Thus, economies of scale can lead to a monopoly or a small number of firms. Depending on the situation, the government may be required to regulate the firm or firms or even to become the sole producer itself. Alternatively, the good or service could be produced by private firms contracted by and regulated by the government. In every case, the appropriate guidelines to be followed attempt to regulate the industry so that it will emulate the results of competitive markets and, thereby, achieve allocative efficiency.
4. Imperfections in Information
One of the more heroic assumptions of the utopian free-market model is that all the players have “perfect information.” In the real world, firms, input owners, consumer groups, and governments are willing to pay to fill in their informational gaps. The term asymmetric information is used to describe an unfair vulnerability of one of the parties—say consumers of prescription drugs. In many market situations the appropriate role of government is straightforward—to insure that all parties have the information necessary to make efficient decisions. In other situations, various moral considerations may complicate the role of government: How should insurance pools be organized for health care, hurricanes, floods, retirement, etc.? Is it fair to exclude those with higher risks? Alternatively, should the rates of those with higher risks be higher? Perhaps social norms will conflict with the private sector’s focus on profits. In summary, information failures in various markets require the government to intervene in order for allocative efficiency to be achieved.
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