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

Street lighting in a Mumbai housing area is non-excludable and non-rival. Why will a purely private market typically under-provide it?

The free-rider problem explains it: because nobody can be excluded, people can benefit without paying, so private firms cannot cover their costs through sales. The good is therefore under-provided or not provided, and government provision funded by taxation is often used.

  1. AConsumers value it at zero, so demand does not exist
  2. BProducers cannot achieve economies of scale in lighting
  3. CFree riders can enjoy the benefit without paying, so firms cannot recover their costs through salesCorrect
  4. DLighting generates negative externalities that raise social cost
  5. Lighting is a demerit good that consumers underestimate

Explanation

Non-excludability means people can use the lighting without paying, which creates the free-rider problem. Firms cannot charge a price that covers cost, so private provision is below the efficient level. Consumers do value it; the issue is revealing and collecting payment.

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