Classification of Goods: 2 Types

1. Private Goods:

Private goods are those goods which yield utility only to the person consuming the good. Only the person who drink a cup of tea for example benefit from the consumption of that cup of tea. The cup of tea consumed by one person cannot be consumed by anyone else. Therefore private goods are those goods, the consumption of which is internalized. Again private good is priced in the market.

All private goods carry a price with it. It may be a full economic price or a subsidized one. The purchase of private goods (market goods) ac­quires ownership, exclusive use and the right to consume sells and dispose, private goods are provided by private and public sectors. However majority of private goods are financed and supplied by the market for price payment.

Those who do not pay its market price or those who cannot pay for it are excluded from the use of this. Thus the ability to price a good, the divisibility of a good and the exclusion principle all go together in the case of private good. The market economy provides private goods and does so effi­ciently.

The market provision of private goods efficiently is based on two principles:

a. The Exclusion Principle:

The market can function effectively in the provision of private goods only in a situation where the exclusion principle applies.

According to the exclusion principle, those who do not pay the market price for goods are excluded from its consumption. For example person A’ consumes a good because he pays for it. Whereas person ‘B’ is excluded from its consumption, since he does not pay for it.

In the case of, private good there is properly rights. That is exchange in the market takes place, only when the commodity to be exchanged bear property titles.

b. The Revealed Reference Principle:

On account of the exclusion principle, the market for private goods functions as auction system. The consumers bid for the commodity in question, and in the process they reveal their preference to the producers.

The producers produce what the consumers reveal through their preference. In this way market operates on information given by consumers.

Those who are unable to reveal their preference will be excluded from consumption. This process effectively functions in a market for private goods. Hence in the case of private goods con­sumption is rival.

A piece of bread eaten by A cannot be eaten by B In the case of private goods productions are guided by consumer demand. In the case of private goods market demand curve is con­structed by summing at each price, the quantity demand by each individual.

2. Public Goods:

Public goods are those goods the consumption of which is externalized. Public goods satisfy the collective wants or social wants in general. Public goods are those goods which are jointly supplied. That is the benefits from consumption of public goods are consumed jointly by more than one person.

The benefits of these public good are not specific to the individuals in a state, but are general in nature and reach the individuals as members of society.

A public good is non-rival in consumption. That is when addi­tional citizens consume the good; others do not have to reduce their consumption of that good. The best example is natural defence. Enjoyments of security and peace under the shadow of strong de­fence by A don’t prevent the other members of the society from benefiting the fruits of secured life provided by national defence.

Since public goods are non-rival in consumption, the marginal cost of providing these goods to additional citizens are zero, once they are produced. Zero marginal cost of provision is another impor­tant characteristic of a public good.

In the case of national defense for example, the cost of allowing one more citizen to enjoy the ben­efits of a well secured and peaceful life is exactly zero.

This is so because when goods are non-rival; in consumption, additional re­sources are not spending when additional persons enjoy the some ben­efits. Where as in the case of a private good, the marginal cost of providing benefit to one more consumer are greater than zero. This is because additional resources are to be expended for the produc­tion and supply of a private good.

The ability to exclude others form enjoying benefits of good is a distinguishing feature between private good and public good. Public goods are characterized by non-exclusion principle.

The service of national defence, flood control programmes, radio signals, mosquito abatement programme in a village etc. are public goods in the sense that the services from these goods available to everyone and no one can be excluded from consuming the same.

Whereas the ability to exclude individuals from enjoying the benefits of goods is a characteristic of many private goods. For example the cable television ser­vices extended by private individuals exclude the individuals from using its services who do not pay towards the monthly charges.

Public goods as such cannot be divided into units and no indi­vidual can personalize its consumption. These goods are provided for the satisfaction of social wants or collective wants of the commu­nity.

Whereas private goods are available in units and an individual can consume it by purchasing the same by giving a price. In the case of private goods, there is the existence of individual property rights. Whereas public goods possess the characteristic of indivis­ibility and collective consumption.

Public goods usually referred as collective goods or social good was defined by prof. Paul. A, Samuelson “as one which all enjoy in common in the sense that each individuals consumption of such a good leads to no subtraction from any other individuals consump­tions of that goods”.

In general public goods possess the character­istic of:

(a) Indivisibility,

(b) Non-rival consumption,

(c) Non- Excludability, and

(d) Collective consumption.

Economists classify public goods into a number of categories. Very often public goods are provided on a variety of basis such as universal entitlement, selective entitlement, free to all irrespective to a person’s income means tested, when entitlement to benefit de­pends on the individuals or household’s income etc. The important concepts in public goods are summarized below.

Merit Wants and Merit Goods:

Public wants can be classified into two categories:

(a) Social wants, and

(b) Merit wants.

According to Musgrave social wants are those wants which are satisfied by services that must be consumed in equal amounts by all.

Such wants can be satisfied through budgetary allocation. Whereas merit wants are those public wants which can be satisfied on the basis of the consumers choice, though there is a general demand and common characteristics for these wants. Merit wants are those wants, the satisfaction of which enhance the meritorious ability of a person.

These wants can be subject to exclu­sion principle, and can be satisfied by the market process, within the limit of effective demand. However usually these wants are taken in public budget on meritonous count.

To quote Musgrave “public services aimed at the satisfaction of merit wants include such items as publically furnished school luncheons, subsidized low cost hous­ing and free education. Goods meant for the satisfaction of merit wants are called as merit goods.”

The idea of merit good springs from, what may be regarded as paternalistic role of the state. For example from the provision of free compulsory education, the benefit is not only to the child who is being educated willingly or compul­sory, but also indirectly to the community at large.

These merit goods are provided for the purpose of increasing the economic well-being of particular individuals or groups.

The justification for government pro­visions of these goods is based on ground of equality in the distribu­tion of goods and services.

Merit goods can be supplied by the mar­ket mechanism through price payment and hence it can be subject to exclusion principle. The merit goods become public goods when the government considers them as meritorious as to be supplied to people free of direct changes through a budgetary provision in addi­tion to what is supplied through the market.

For example educa­tional services, public health services and samtation etc. which are typical examples of merit goods can be provided by the market sys­tem for a price payment. Considering to its social importance and welfare value, government may choose to supply them through bud­get, even though consumers can avail such services from private market.

Therefore merit wants are those goods and services which lie in the border line wants. That part of the service which is sup­plied by the market mechanism is a private good; whereas the part of the same type of service which is supplied through the budget will be called merit wants or merit goods. Therefore merit goods are provided through budget to ensure quality and social justice.

Pure Public Good:

A pure public good is a public good where the marginal cost of pro­viding it to an additional person is strictly zero. It is also impossible to exclude people from receiving the good. A pure public good pos­sess three characteristics.

Firstly there is an element of jointness or non-rivalness in consumption. That is if a commodity is currently being made available to individual ‘A’ it can simultaneously be made available to individual ‘B’ without any extra cost. The television broad cast signals is a good example.

Secondly in the case of pure public good, there is an element of non-excludability, in the sense that ‘B’ cannot be excluded from enjoyment of the commodity irrespective of the fact that whether he wish to have it or not.

Thirdly it is impossible to reject the supply of a particular good or service, so that if it is provided for A, then B cannot fail to participate in it. Then B becomes a ‘forced rider’. When all these conditions are satisfied, different people will consume different quantities of a good or service.

Optimal Provision of Pure Public Good:

Optimal provision of pure public good happens when marginal social benefits equal marginal social costs (i.e., MSB = MSC).

The point can be made clear by making a distinction between the provision of private good and pure public good under conditions of optimality. As far as a consumer in a private competitive market is concerned, relative consumption of different commodities will be proportional to their relative prices.

No consumer can gain extra satisfaction by slightly altering the pattern of his expenditure. If producers act so as to maximize their profit, they will produce good up to the point at which the marginal revenue from sales equals the marginal cost of production.

The factor payment will be at optimum where the mar­ginal cost of any one factor is equal to the value of the marginal net product of that factor. The market demand curves for private goods are the horizontal summation of all individual demand curves. For ex­ample consider a market for a typical private good say orange.

Com­posed of three consumers, A, B and C. If at the price Rs. 3/-, A purchases 3 oranges, B purchases 5 oranges and C purchases 6 oranges. Then the market purchases amount to 14 oranges. In this case, the market demand curves are constructed by summing at each price, the quantity demanded by each individual.

In usual case market demand for public goods are also the summations of the demand curves of all individuals. But there is a differ­ence. By definition pure public good is characterized by non-rivalry in consumption. Hence a given quantity of pure public good pro­duced and supplied will be equally consumed by all members.

How­ever the valuation of each individual will be different. In the case of pure public good, everyone must consume the same amount. What is available for any one individual is available for everyone else.

Hence in such a situation the consumes differ in the marginal valuation they place on a given quantity of the commodity rather than in their con­sumption of it. Therefore in the case of a pure public good, demand curves now have to be added vertically rather than, horizontally.

Let us illustrate the point with the help of a graph. The figure No 2.8A shows the demands of consumers A, B and C for a particular public good. Even though all the consumers consume the same quantity they do not equally value the public good.

When OQ quantity of output is produced, all three individuals can collectively share the benefits flowing from that level of production.

Demand curves are marginal benefits curves and correspondingly price measures the marginal valuations that indi­viduals place on successive quantities of goods. Market demand at QQ output level is determined by the summation of the marginal values that each individual attach on OQ level of output.

Quantity OQ is valued as. Rs. 1/- by A, Rs. 21- by B and Rs. 31- by C. Mar­ginal social benefit corresponding to OQ level of output is obtained by vertically summing the valuation of each individual (i.e. EMB) and it amount to Rs. 6/-.

Hence, as stated to construct market demand for any public good, we vertically sum the demand curves of each individual in the market.

Efficient Output Level of a Pure Public Good:

Optimal output of pure public good is based on a Comparison of marginal social benefit (MSB) with marginal social cost (MSC) Fig­ure 2.8 B, super imposes from the demand cuvees from figure 2.8 A. on to the marginal cost curve for the public good.

 

In the figure, it is assumed that MSC is constant at Rs. 6/- per unit. The optimal out­put is realized at OQ level, where MSB = MSC. Consider an output level less than OQ. At OQ, level of output, for example, MSB > MSC by distance ‘ab’. This indicates that value attributed on these goods by society exceed opportunity cost of producing this good.

At out­put level OQ₂, MSB < MSC by distance ‘de’. At this level the values placed a good by society are less than the opportunity cost of producing this good. Only at point ‘c’, where MSB = MSC, resources are allocated optimally for the production of the pure public good. At this point total net social benefits will be the maximum.

Therefore the efficient production of pure public good requires that the sum of the marginal rate of substitution, equal the marginal rate of transfor­mation. Moreover efficient production occurs at the intersection of the collective demand curve, formed by vertically adding the demand curves for such each individual with the supply curve.

The efficient output of a pure public good is financed by govern­ment through budgetary provisions. However taxes must be collected from the citizens to provide the funds required for the production of pure public good.

Financing a public good through tax resources raises the question of sharing the tax burden between individuals A B and C in our example.

Therefore efficiency consideration alone does not permit us to say how tax burden should be divided. In this case equity considerations are also involved. One possibility is to charge each tax payer an amount per unit equal to the marginal benefit the tax payers receives from the provision of the public good.

In our example at optimum output OQ, the MSB = MSC = Rs. 6/-. In this case the respective marginal benefit for A B and C are Rs. 1, Rs. 2 and Rs 31- Then it is likely that each tax payer contribute in propor­tion to the benefit he receives.

Another possibility is equal sharing of the cost. This financial arrangement of cost sharing depend upon the bargainers skills of each individual. For example if A and C are superior bargainers, respective contribution for A, B and C will be Rs. 1/- Rs. 31- and Rs. 2/’-, respectively.

However fiscal theorists have paid much attention to lindhal equi­librium, because it corresponds to the socially optimum quantity of output. When Lindhal prices are charged, voluntary agreement among all individuals in society results in consumption of socially efficient levels of public good.

Lindhal pricing suggest a guide for the public sector, that results in both optimal quantities of public goods and unanimous agreement on how many resources should be devoted to production of public goods.

Impure Public Goods:

A pure public is one in which the marginal cost of producing it to an additional person is strictly zero and it is impossible to exclude people from receiving the good. National defence is one of the few examples of a pure public good.

In reality the stringent conditions for pure public goods are un­likely to be met very often. Many public goods that government provides are not pure public goods in this sense.

Firstly joint consump­tion property will be partly violated. Although all individuals may con­sume the services of the same quantity of the public good, the ben­efit obtained from the public good decreases as more persons share in its consumption.

Public goods have the property of non-rivalness in use, while private goods are completely rivalrous. Impure public goods may be partly rivalrous. Given the quantity of public good allowing an additional individual to use that commodity does not prevent the previous users of it from using it.

However it reduces the benefit obtained by previous users. Thus these are some opportunity cost involved in admitting more users. Fire protection is like a private good, in the sense that exclusion is possible.

Individuals who refuse to contribute to the fire department will not be given the help in the event of a fire. But fire protection is like a public good, in the sense that marginal cost of covering an additional person is very low.

Most of the time fire fighters are not fully engaged, but may be waiting calls. Hence protecting an additional individual involves little extra cost. Only at rare occasions, when incident of fire breaking are more, there will be a significant cost to extended fire protection to an addi­tional individual.

In this case exclusion is also not possible. Fire protection measures adopted by a person indirectly benefit the per­son in the next door in a building even though he doesn’t pay for it.

The phenomenon of partial rivalness in the case of an impure public good is termed as congestion in the economic literature.

The opportunity cost of allocating more users for the public good or re­duction in benefit to those already consuming it is called the con­gestion cost. By a congested public good, we mean a situation in which more individual users are added to share the consumption of a fixed amount of the public good.

Hence we shall speak of congested public good as those for which the use exhibits only partial rivalness. Public goods exhibiting congestion as more users are added may be of various kinds like local public good, mixed good or club good.

In this case very often the example of a local public good like fire station or police station is considered. As stated earlier as more persons are covered by a given size of fire or police station, the benefit per person may fall because of the probability that the con­cerned service will be in use elsewhere, when required.

Club goods like swimming pools, golf courses, are typical examples of impure public goods subject to congestion. The analysis of congested pub­lic good involves determining not only how large the facility ought to be, but also how many users ought to be admitted to using it.

The optimality condition for the output of congested public good is derived by a mere extension of the condition in the case of pure public good.

Let us consider communities consisting of a given num­ber of consumers (y) each individual have a set of preferences for the public good in consideration, depending upon the total number of users (Y).

As ‘Y’ increases, the preference map of each consume will change. Given the number of uses, the optimality condition fol­lows from that of a pure public good.

The optimal quantity will be arrived when the sum of the marginal benefits from the last unit sup­plied just equals the marginal cost of supplying it.

Mixed Goods or Quasi Public Goods:

Another variant of impure public good is the mixed goods. That is the mix of services that stem from the provision of the good.

Sup­pose, a person ‘A’ derives private benefit from being vaccinated against polio. He derives not only a private benefit but also generate an ex­ternal effect in so far as, he reduces the chance of infection for all other individuals with whom he comes into contact.

It is clear that the external benefit associated with the consumption of a private services, itself bears the characteristics of a public good. Likewise education may improve an individuals earning profit.

At the same time it may facilitate basic research creating non-rival and non-ex­cludable knowledge or information, which benefits others in the com­munity. Moreover the industry will indirectly benefit from the quality of labour force steming from education facility.

Therefore recognition of the private public mix means that the goods can be viewed as having private benefits as well as external benefits which resemble the characteristics of a public good.

From the point of view of con­sumption, the major difference between a pure public good and quasi-public good or mixed good, is that the benefits of the former are completely indivisible and must be consumed equally by all, while the latter creates individual benefits (divisible and assignable) as well as public benefits.

In many democratic countries quasi-public goods are publically financed, mixed goods can be defined in an­other way. The goods and services which are partly supplied by the private market and partly through the Budgetary provision can be categorized as mixed goods.

A good example is the public distribu­tion system in India. Under the system essential goods are supplied to the poor people at subsidized prices. Therefore, wheat, rice or sugars purchased from the relation-shops are charged lower prices than those prevailing in the open market, for them. Public distribu­tion is made possible through government subsidy, which involves budgetary expense.

To the extent of subsidy value, these commodi­ties are associated with elements of public want. Therefore, these are mixed goods, which are partly private and partly public good.

Public Intermediate Goods:

A pubic intermediate goods comes under the category of impure pub­lic good, because it resembles the characteristics of private and public goods. Public intermediate goods are goods which serve as inputs into the production processes of several producers simultaneously.

Joint consumption property is the basic characteristic of public intermediate goods. In this sense it resembles a public goods. Take the case of public intermediate goods or public input, say ‘L’ which is used as an input by ‘n’ firs jointly.

Then the public input ‘L’ has the property of jointness or non-rivalness in use. Each firm uses the same given quantity of it so that adding more users does not detract from the benefits received by the existing user.

In such cases, given the number of users firms, optimal quantity of ‘L’ is determined exactly as in the public goods case- The benefit of ‘L’ accrued simul­taneously to all ‘n’ firms.

Club Goods:

A classic example of impure public goods is club good. It is an intermediate case between purely public good and private good. In the case of club goods exclusion is possible, but the optimal size of the club is in general, larger than an individual.

A simple example is a cinema show. Here it is possible for the good to be priced (exclu­sion can be practiced) and for a number of people to share the same good without diminishing each other’s consumption of it. The size of the optimal sharing group is that which maximizes their joint utility.

Hence club goods are those goods which are non-rival in consump­tion but the principle of exclusion can be applied in the market by consumption sharing arrangements.

Theory of Clubs:

Theory of clubs is part of the theory of impure public good. Prof. Buchanan (1965) has introduced a theory of clubs to explain the condition for efficiency in the provision of such goods.

Theory of clubs is the voluntary cooperation among individuals seeking mu­tual advantages. It will not be advantages for individuals to purchase some goods (e.g., swimming pool, or parks) because of the high cost element involved in the construction of such goods so the indi­viduals may think in terms of finding a way of sharing the costs.

For example persons A’ may enjoy swimming, but the benefits he re­ceive maybe greatly over weighed by the cost of putting a swimming pool in A’s backyard.

Apart from the fixed cost of building the swim­ming pool, A’ has to incur maintenance cost and he has to sacrifice the limited available yard space. Therefore larger the costs, greater will be the cost saving realized by sharing the pool with other indi­viduals. Thus cost savings are clearly possible, when costs are shared among a collection of individuals.

Hence the analysis of the theory of clubs is concerned both with the optimal output of a club good or congested public good and with the optimal number of uses or mem­bers.

A club is an Organisation which offers a shared collective good exclusively to its members, on the basis of cost sharing either equally or on the basis of some agreed principles. Sharing of goods is likely to occur among individuals with common interests.

Hence swim­mers are very often attracted to swimming clubs, gun owners at­tracted to gun clubs. When the interest of groups are clear and well defined, cost sharing on the basis of voluntary agreement takes place smoothly.

Sports lovers don’t equally enjoy all kinds of sports. So we can find clubs devoted to a particular spot such as football, cricket, biking, basketball etc. rather than an all-inclusive spots club. How­ever some clubs do provide more than one activity.

A club may be defined as a voluntary group deriving mutual benefit from sharing one or more of the following; production costs, the member’s characteristics, or goods characterized by exclud­able benefits.

An individual can determine whether to join clubs on the basis of the benefits or costs of membership. The benefits asso­ciated with membership are measured in the same way as marginal benefits of public goods are measured.

A person joining a swimming club is determined on the basis of the utility the swimmers enjoy, in relation to the cost of getting enrolled in the club. Cost of forming clubs includes both fixed and variable costs which are reflected in con­struction costs and membership fees.

Cost also includes transaction costs like permit fees, insurance liability and other miscellaneous. Higher the cost, lesser is the probability of forming groups. Optimal membership sizes of clubs are determined by the space and number of users to be admitted. People can consume a club good, without diminishing the benefits enjoyed by others.

Even though benefits from club goods are non-rival, many club activities suffer from congestion. The congestion properties of goods are an important determinant of optimal membership size.

The more easily congested are the activities of the clubs, the smaller is optimal membership size. The ability to exclude free riders from the benefits of clubs is the rationale behind forming clubs. Membership initiation fees and dues provide the financial means to meet the cost of providing a clubs activity.

Application processing is an important screening de­vice, for excluding individuals who cannot contribute to the goals of the club. The administrative committee perfects the interest of the clubs members by rejecting applicants who are unable to provide adequate reference and appropriate employment and income de­tails.

The voluntary nature of clubs allow any member, who losses from membership to leave the club. Since no one is forced to join or remain as a member, no one losses when clubs are formed to deliver public goods.

Voluntary membership helps the clubs to make effi­cient arrangements for the provision of public good facility in line with Pareto optimality condition. The voluntary nature of membership places a self-imposed discipline on club officers to provide high qual­ity, low cost activities for its members.

The club goods congestion-consumption relationship can be expressed as:

C = f (X, N) where ‘C’ indicates total cost ‘X’ the amount of the good and ‘N’ the size of the club. Here the assumption is that all ‘N’ individuals consume identical quantity and quality of the good. For a fixed value of ‘C, X declines if ‘N’ increases. Where as assuming ‘N’ constant, ‘X’ increases with gains in ‘C’.

To summaries, club memberships are pareto-efficient if similar individuals are assigned to each club. In most situations a club can be efficiently run by its members, the government or private firms. In the case of a private firm, the optimal charges are identical to the users fees for member owned and operated clubs.

The important point is that when public goods are provided in private markets the club has an inherent incentive to be well run and accountable to the preferences of its members. Therefore the theory of clubs finds its strongest application in the analysis of a rationale for government decentralisation.

Local Public Goods (Tiebout Model):

Public goods for which the benefit accrue only to those located ‘near’ them are termed local public good. The market generally fails to provide public goods efficiently. The root cause of the problem is that the market doesn’t force individuals to reveal their true preference for public goods.

Every One has an incentive to be a free rider, Hence the usual argument is that government intervention is required, Tiebout (1956) argued that the ability of individuals to move among jurisdiction produces a market like solution to the local public good problem. Individuals vote with there feet and locate in the community that offers the bundle of public services and taxes they like best.

Tiebout is of the view that individuals select the local community whose provision of local public good and tax prices best satisfies their pref­erences. His analyse is farmed as a direct response to Samuelsons (1954) conclusion that individuals would not reveal their preferences for public goods.

Tiebout argues that in the context of a local com­munity, individuals will reveal their preferences, by moving to the locality that best reflect their tastes and offer the preferred tax ben­efit mix. In equilibrium, people distribute themselves across commu­nities on the basis of their demand for public services.

Each indi­vidual receives the desired level of public services and he cannot be made better off by moving. This equilibrium is Pareto efficient, and government action is not required to achieve efficiency.

In an economy consisting of many localities each of which pro­viding a different mix of public goods and taxes, individuals will have an incentive to migrate to those communities which they prefer. The mobility of consumers which is typically coiled voting with the feet provides an alternative mechanism by which individuals may volun­tary reveal their preference.

Tiebout claimed that in a world of perfect mobility, of individuals among localities, the preference revelation mechanism will function perfectly as an Allocative mechanism, lead­ing to an optimal configuration of localities with optimal population and provision of optimal quantity of public goods.

Tiebout model is based on a number of properties. He assumed an economy consisting of several localities which satisfies the fol­lowing properties, leading to the optimal provision of public good locally:

Firstly consumers are perfectly mobile between communities.

Secondly there are a large number of communities offering a wide variety of choice of expenditure-tax mixes.

Thirdly consumers possess per­fect knowledge about the revenue and expenditure patterns of the various communities.

Fourthly there are no spillover between communi­ties. Local public good supplied by one community benefit only resi­dents of that community.

Fifthly there is an optimal community size. Those communities below the optimal size see to expand by at­tracting residents and vice versa.

Tiebout argued that if these assumptions were held well in an economy, there will occur Pareto optimal allocation of public goods within the communities and all communities would be of the optimal size.

Tiebout model is not a perfect description of the real world. In practice people are not perfectly mobile. Moreover in the world we cannot find enough communities with a bundle of services that perfectly suit to the requirements of different families.

Within many communities, there may exist massive income differences and hence presumably different desired levels of public services provision. How­ever the model highlights the significance of decentralized provision of public good and decentralization of the fiscal federal system.