Major Issues in Pakistan’s Economy - Spring 2023

Market Failures, Public Goods, Mixed Goods and Externalities

From the desk of Dr. Asim Bashir Khan

Market Failures, Public Goods, Mixed Goods and Externalities

There are three major market failures: public goods, mixed goods, and imperfect competition. Goods
are divided into three categories: public or social goods, private goods, and mixed goods. To identify
the type of good, first ascertain whether the good is excludable or non-excludable and rival or non-rival.

Excludable and Non-Excludable Goods

If the owner of a good can prevent others from using the good, the good is excludable. Otherwise, it is
non-excludable.

Excludable Good
Owner of readymade garments store allows only those to take away the garments who pay the price
asked for, and can prevent other from using his garments.

Non-excludable Good
National defence is a non-excludable good. If a system of national defence is in place to protect a
country from foreign invasion, then everyone living in the country will enjoy the security provided.
Since the owner of non-excludable goods cannot force anybody to pay for using them. Obviously, in
market economy profit maximizing producers will supply excludable goods only. They will never
produce non-excludable goods.

Rival and Non-Rival Goods

If use of a particular unit of a good by one person does not prevent others from using the same unit of
good at the same time, the good is non-rival. Otherwise the good is rival. Market economy cannot
provide non-excludable goods. Nor can it bring about the efficient utilization of non-rival goods. In
these areas, therefore, government interventions or government provisions are needed.

Social Goods or Pure Public Goods

Goods that are both non-excludable and non-rival are pure public or social goods, while those that are
excludable as well as rival are pure private goods.

Distribution of Public Goods in India

Distribution of Public Goods in India varies widely across different regions of India. In an interesting
study, Bunerji (2004) identifies certain key factors which he thinks might be responsible for the kind
of uneven distribution of public goods that exist in India. These factors are geographical, historical,
and ethnic in nature. Of the geographical factors ‘being costal’ is found to be the most important in
influencing spatial distribution of public goods, the reason is that people living in coastal areas have
greater exposure to international trade. Hence, they are more aware of the kind of amenities that are
available in foreign countries. Accordingly, they demand public goods more fervently. Besides being
costal, other geographical factors that are also found to be important. The cost of providing public
goods in mountainous region is much higher than that in the plains. Hence, the latter have larger
share of public goods than the former. Per capita cost of providing public goods is much less in
densely populated regions than in thinly populated ones. Accordingly, the former has a larger
concentration of public good in India. Historical factors have also been found to be significant. Three
different kinds of land tenure systems existed in India, namely, zamindari (landlord-based system),
royatwari (peasant-based system) and mahalwari (village-based system). Zamindars (landlords) were
politically quite strong, and the British had relatively much less control over rent in the zamindari

Institute of Business Administration, Karachi. Page 1 of 2

Major Issues in Pakistan’s Economy - Spring 2023
Market Failures, Public Goods, Mixed Goods and Externalities
From the desk of Dr. Asim Bashir Khan

areas. In fact, rent in these areas was fixed for ever in nominal terms. In other regions the British
could and did raise rent whenever there was an increase in productivity. Accordingly, the British
were much more interested in investing in productivity-enhancing infrastructure in non-zamindari
areas. Landlords on the other hand were mostly absentee landlord who derived bulk of their income
from non-agricultural sources. Hence, they had little incentive to invest in land. For these reasons
areas under the zamindari system attracted much less public good. Ethnic factors are also to be
important. Minority communities have always been discriminated against. They constitute the bulk
of the poor population with little access to education or healthcare facilities. They are much less
aware of their rights and legitimate dues and, therefore, less articulate in their demand for public
goods. Accordingly, as has been found by Banerji, there is less availability of public goods in areas
where the minority communities are pre-dominant in population.

Mixed Goods and Externality

Mixed Goods
Goods that share characteristics of both pure private goods and pure public goods are mixed goods.

Externalities
Good whose benefits or costs cannot be fully internalized by the owners, i.e., the goods whose benefits
or costs do not remain confined entirely to their consumers or producers, but spill over to others
automatically, generate externalities.
When activities of an economic agent directly affect the welfare of another and not indirectly via the
market mechanism, externalities are generated. Consumption of cigarettes, for example, adversely
affects the welfare of those happen to be in the vicinity of the smokers.

Pigouvian Subsidy and Tax

Externalities lead to sub-optimal allocation of resources. The problem can be tackled in number of ways.
Some of these are Pigouvian taxes and creation of markets. Market cannot produce mixed good that
generate externalities efficiently and there is a room for the government, as pointed by Pigou, to
intervene with tax-subsidy measures to make their output socially optimum.

Merit Goods
Merit goods the concept introduced by Musgarve (1957, 1958), presuppose the existence of community
interest as distinct from self-interest. People as member of community feel obliged to support
government interference with individuals’ taste and preferences in respect of consumption of certain
types of goods. When the government subsidizes food consumption of the poor instead of giving the
subsidy as transfer income, the governments want the poor to consume more food than what they would
have consumed had they got the subsidy as transfer income. Merit good are different from mixed goods.
Consumption of mixed goods yield benefits (positive or negative) to all or some of the individuals who
do not consume them directly. Merit goods on the contrary, benefit only their direct consumers.

Common Access Resource

Natural resources over which there is no established private ownership. They are owned by no one,
thus available to anyone to use. Their existence gives rise to the tragedy of the commons.

Common resources are non-excludable (no one can easily be excluded from using them) but rivalrous
(one person’s use diminishes the benefits the resources can provide others in society).

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