Thursday, August 03, 2006

People want brightly lit and safe roads. They also want reliable health services and quality education.

Government regulation is the only way to provide them.

To what extent do you agree with the above statement? [25]


In modern economics, goods and services are normally provided by the free market. However certain goods and services are provided by the government, for different reasons.

Public goods are by nature non-diminishable and non-excludable. They are non-excludable as once they are provided for, it is very difficult to prevent others who have not paid for them from enjoying the benefits they offer. For example, when “save roads” are provided, how can it be safe only for those who have paid for it and unsafe for those who have not? This gives rise to the free-rider problem, wherein consumers choose not to divulge their demand for the good, hoping instead that others perhaps less intelligent or more desperate for the good will pay for it. Without market demand, market forces cannot act to determine a price for the good, hence firms will not provide it.

In addition, public goods are also non-diminishable. The consumption of the light from a streetlamp will no decrease the amount of light available for the next person. Thus marginal cost, which is defined as the cost of producing an extra unit of output, is effectively zero (MC=0).
Firms determine their equilibrium price and output by the point where MC=MR, MR being the additional revenue the firm earns by producing an extra unit of output (marginal revenue). If MC=0, then the equilibrium price they should charge should be equal to zero and the good should be provided for free. It is hence unlikely that private firms would be willing to supply a good that will provide no returns.

Provision by the government is most feasible then as the government can provide the good and charge it via compulsory taxes paid by the citizens of the country. This way, public goods are provided for and payment is received.

There are however problems with government provision of public goods. A major problem is the difficulty with which the government has in determining the optimum output level. If a survey is taken, consumers may overstate their value of the good if they are trying to make the government produce more of it, or they may understate their value of the good if they suspect that their valuation of the good will be used as the basis for a tax imposed on them in future.

Next, it is difficult to ensure that government provision is will be efficient. If the government hires an electric company to stall street lighting for instance, the company may be wasteful in its method of production since its costs are borne by the government.

Thus although public goods are ideally provided for by the government, fundamental problems with government provision do exist.

The public also requires reliable health services and education. Such goods are viewed as merit goods which are seen to be beneficial to individuals as well as to others in society.

Merit goods are often goods with positive externalities, as such the marginal social benefit(MSB) of producing or consuming them is greater than the marginal private benefit(MPB). However in a free market, the output level of goods are determined by the intersection of the marginal cost (MC) and MPB curves, MC being the price of the good and MPB being the extra satisfaction acquired from consuming an additional unit of the good.

As a result the equilibrium price is Pp and equilibrium output Qp. This level of output is viewed by the government as lower than desired, Qs being the socially-optimal level of output. As can be seen from figure 2, a deadweight loss to society of the shaded area is generated from underproduction of merit goods.

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Education for example benefits an individual in terms of his wage rate and perhaps other personal benefits like self-esteem. To the society however, education helps to improve productivity of labour hence economic growth, as well as development of more civic-minded and mature citizens. Such external benefits, measured by the vertical distance between the MPB and MSB curves (the length EB in figure2), are not taken into account by the free markets.

Government regulation may help to increase the production of such merit goods. For example, the government subsidizes certain vaccinations for diseases like Hepatitis B. In addition, primary education is made compulsory in certain countries.

It is then, desirable that merit goods are provided by the government. Here again, certain problems arise with government provision. Firstly, what are merit goods? Such is a value judgement made by the government which may not be acceptable to everyone in the society.

Next, what is the extent to which the government should regulate the provision of merit goods? It is difficult to measure accurately in nominal terms the external benefits, since they are the benefits to those not involved in production or consumption of the good.

Lastly, government regulation may not be the best production of merit goods. It is not simply health services or education that is desired, but quality health services and education. If the government can only ensure shabby merit goods, the public is almost better off without them.

Since merit goods are private goods, it is feasible that the free market provides them. Private hospitals, for example, provide excellent healthcare services.

Hence one must note that government regulation should be flexible, with stricter rules set on basic healthcare and education and more lax ones, such as simple campaigns for fitness, to allow freedom of choice. It should also allow for the free market to provide for such goods, with certain government interventions like subsidies to encourage production and consumption of merit goods.

In conclusion, government regulation with respect to provision of public and merit goods is necessary, especially for public goods, but it should not take over the role of the free market ultimately.

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