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IAI Actuarial Core Principles · Business Economics · Government intervention in a market

Street lighting in a housing colony is non-excludable and non-rival in consumption. Why will a purely private market tend to under-supply it?

A private market under-supplies street lighting because of free-riding. Since nobody can be excluded, beneficiaries have no reason to pay, so suppliers cannot recover costs. The good is valued by users, and the marginal cost of an additional user is zero, so the issue is non-payment.

  1. AConsumers value it at zero
  2. BCosts of provision are always negative
  3. CFree-riding means providers cannot collect payment from beneficiariesCorrect
  4. DMarginal cost of an extra user is very high
  5. Governments are prohibited from providing it

Explanation

Because nobody can be excluded, people can enjoy the lighting without paying. Individuals have an incentive to free-ride, so revenue is insufficient to cover costs and private firms do not supply the efficient quantity. The problem is not zero valuation or high marginal cost; marginal cost of an extra user is zero.

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