State provision

Overview

Government provision of a good mean in practice, opportunity cost of state provision matter when judging it and free provision create rationing by waiting.

What you need to know

Answer each one before you reveal it.

Questions from this subtopic

Each one with the model answer underneath.

1. 1

   What does government provision of a good mean in practice, and how is it paid for?

   Model answer

   The state produces the good itself, or commissions it, and supplies it free at the point of use or at a price well below cost, with the money coming from general taxation rather than from the users. Street lighting, flood defences, policing and school places are examples. Because the payment is separated from the act of consuming, a consumer's decision to use the good no longer depends on their income or on what it costs to supply the extra unit. That is the source of both the strengths and the weaknesses of the instrument.

2. 2

   Why is direct state provision the natural instrument for a pure public good?

   Model answer

   A pure public good is non-excludable, so no supplier can charge for it, and non-rival, so the marginal cost of an extra user is zero. Every consumer therefore has an incentive to free ride, and no market emerges at all: private output is zero rather than merely too low. A tax or a subsidy adjusts the quantity a market already produces, so neither has anything to work on here. Provision funded from compulsory taxation is the only instrument that both supplies the good and solves the free-rider problem by removing the choice to pay.

3. 3

   Analyse how making a merit good free at the point of use moves consumption towards the social optimum.

   Model answer

   Where a good carries external benefits, marginal social benefit lies above marginal private benefit and the market quantity is below the optimum. Setting the price at zero removes the private cost of consuming entirely, so consumers extend along their demand curve to the quantity at which their own marginal benefit falls to zero. If that quantity is close to the point where marginal social benefit meets marginal social cost, the under-consumption is removed and the external benefits are captured. Access no longer depends on income, so the households previously priced out are the ones brought in, and because they were consuming least before, the external benefits their consumption now generates are the ones that were being lost.

4. 4

   Does state provision destroy the price signal, and how much does that matter?

   Model answer

   The objection has force: with no price, consumers reveal nothing about how much they value the service, so planners must guess what to provide and in what mix, and they cannot tell whether an extra ward or an extra school would deliver more. Resources are then allocated administratively and can be misdirected for years. Against this, for a pure public good there was never a price signal to lose, and for a merit good the price signal was misleading in the first place because it reflected private rather than social benefit. The objection is strong for ordinary goods and weak for the goods provision is actually used for.

5. 5

   Why does the opportunity cost of state provision matter when judging it?

   Model answer

   The service is free to the user but not free to society: the resources used could have produced something else, and the tax revenue that funds it could have gone to another programme or been left with households. Judging provision therefore means comparing the value of what is provided with the value of the best alternative use of the same money, not simply observing that people benefit. Higher taxation also has effects of its own on incentives to work and invest. A programme worth having in isolation may still be the wrong call if a better use of the money exists.

6. 6

   Why does free provision create rationing by waiting, and what is wrong with that?

   Model answer

   At a price of zero, quantity demanded is at its maximum, but the quantity the government can supply is limited by its budget, so demand exceeds supply. Since price cannot do the rationing, waiting lists, triage and queues do it instead. The objection is that waiting is a real cost, borne in lost health, lost earnings and anxiety, and it is a cost that produces no revenue for anyone: nobody gains what the waiting household loses. Waiting also tends to fall hardest on those least able to persist or to arrange an alternative, which undercuts the equity aim.

Other ways to work this

The same content, four other ways.

What is inside Levo

Six ways to work the same material.