To define Public Goods we need two concepts: Excludable goods and Rival goods.
- Excludable goods can be prevented from use (food) in contrast to non-excludable goods that can always be consumed (radio or air).
- Rival goods cannot be consumed without diminishing others’ use of it (food) in contrast to non-rival goods (mp3-files).
Based on the two properties four types of goods can be defined:
- Private: Excludable & rival
- Public: Non-excludable & non-rival
- Common: Non-Excludable & rival
- Club: Excludable & non-rival
As Public goods are non-excludable and non-rival goods, it is hard to provide public goods with private markets because of the free-rider problem. A free rider receives the benefits of a good, but avoids paying for it.
If the benefit of a public goods exceeds the cost of providing it, the government should provide the good by collecting tax to pay it. However, measuring the benefit is usually difficult. An approach to solve the problem is to perform cost-benefit analysis. Nonetheless, such cost-benefit analyses are imprecise and provide less efficiency than private markets.
In contrast Common Goods are non-excludable and rival. This causes the Tragedies of the Commons as free-riding is the best option for any rational, self-interested actor (i.e. consuming as much as possible without contributing). Several policies are used to restrict the tragedy:
- Regulated resources
- Corrective taxs
- Auctioning of permits
- Privatisation (e.g. make land private, sell in parcels)
Elinor Ostrom developed 8 principles to govern commons:
- Clearly defined boundaries;
- Rules regarding the appropriation and provision of common resources that are adapted to local conditions;
- Collective-choice arrangements that allow most resource appropriators to participate in the decision-making process;
- Effective monitoring by monitors who are part of or accountable to the appropriators;
- A scale of graduated sanctions for resource appropriators who violate community rules;
- Mechanisms of conflict resolution that are cheap and of easy access;
- Self-determination of the community recognized by higher-level authorities;
- In the case of larger common-pool resources (CPR), organization in the form of multiple layers of nested enterprises, with small local CPRs at the base level.
This illustrates that institutions are necessary to manage common goods and they require a high level of administration.