50: Conflicts of Interest in Public and Private Expenditure

Wednesday, February 01, 2012


Public Goods and Merit Goods

A public good is an item which cannot be withheld from one consumer without withholding the good from all customers. Non payers cannot be excluded. These goods are characterized by non-excludability and non-rivalry. Since public goods, such as street lighting, can be used free of charge, they will not be supplied by private-sector firms. Public goods are therefore supplied by central and local government.

A merit good is a useful item, such as education, which some people are unwilling to buy. Merit goods are supplied by the public authorities either free or for a minimal charge so as to enlarge consumption.

Social Cost

It is the total costs (inconveniences) to the society of an economic activity. It is the full opportunity cost.

The private cost to a motorist of driving from Cornwall to Scotland is the cost of petrol and oil and the wear and tear on his car. However, other people have to put up with the externalities of the journey, for instance the noise, smell, pollution and traffic congestion the motorist helps to cause along the way.

If we add on to private cost an amount of money to compensate for the inconvenience caused, the overall figure will be the social cost of the journey:

Private costs + Externalities = Social cost
(Cost to individual) + (Cost to other people) = (Cost to everyone)


Reducing Social Costs

So as to minimize social costs governments can take the following measures.
  • Impose a tax (such as pollution tax in USA, France, Hungary etc)
  • Raise the rate of excise duty on products like tobacco, alcohol etc.
  • Give production subsidies for firms with large external benefits.
  • Nationalize the firms to minimize external costs
  • Take legal actions against firms creating external costs.
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