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There is a category of goods where the positive externalities are so great that the free market, whether perfect or imperfect, may not produce at all. They are called public goods.
Examples include lighthouses, pavements, flood-control dams, public drainage, public services such as the police and even government itself.
Public goods have two important characteristics: nonrivalry and non-excludability.
• If I consume a bar of chocolate, it cannot then be consume by someone else. If, however, I walk along a pavement or enjoy the benefits of street lighting, it does not prevent you or anyone else doing the same. There is thus what we call non-rivalry in the consumption of such goods. These goods have large external benefits relative to private benefits. This makes them socially desirable, but privately unprofitable. No one person alone would pay to have a pavement built along his or her street. The private benefit would be too small relative to the cost. And yet the social benefit to all the other people using the pavement may far outweigh the cost.
Public good A good or service that has the features of non-rivalry and non-excludability and as a result would not be provided by the free market.
Non-rivalry Where the consumption of a good or service by one person will not prevent others from enjoying it. If I spend money erecting a flood control dam to protect my house, my neighbours will also be protected by the dam. I cannot prevent them enjoying the benefits of my expenditure. This feature of non-excludability means that they would get the benefits free, and would therefore have no incentive to pay themselves. This is known as the free-rider problem.
The free-rider problem. People are often unwilling to pay for things if they can make use of things other people have bought. This problem can lead to people not purchasing things that would be to the benefit of them and other members of society to have.
When goods have these two features the free market will simply not provide them. Thus these public goods can be provided only by the government or by the government subsidising private firms. (Note that not all goods produced by the public sector are public goods.)
Definitions
Non-excludability Where it is not possible to provide a good or service to one person without it thereby being available for others to enjoy.
Free-rider problem When it is not possible to exclude other people from consuming a good that someone has bought.
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