Consider the following statements regarding Public Goods and Externalities : 1. Non-rivalry and non-excludability are two characteristics of Public Goods 2. Market can provide the optimal amount of a good in the presence of externalities Which of the statements given above is/are correct ?
- A.1 only
- B.2 only
- C.Both 1 and 2
- D.Neither 1 nor 2
Correct answer
Explanation
The correct answer is A, 1 only. Public goods are non-rival and non-excludable, but externalities cause market failure, so the market does not supply the optimal amount.
A good is non-rival when one person's use does not reduce what is left for others, and non-excludable when no one can be kept from using it. National defence, street lighting and a lighthouse are standard examples. Because people can enjoy them without paying, private firms under-supply them and the state usually provides them. An externality is a cost or benefit that falls on people outside a transaction, such as pollution from a factory or the benefit of vaccination to neighbours. Since the market price ignores these effects, goods with negative externalities are over-produced and goods with positive externalities are under-produced.
Why the others are wrong: B and C, statement 2 is false because externalities are a classic cause of market failure. D, statement 1 correctly describes public goods.
Exam tip: public goods and externalities are the two textbook cases of market failure that justify taxes, subsidies or state supply.
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