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

Street lighting in a town is non-excludable and non-rivalrous. Why is a purely private market unlikely to supply the socially desirable amount?

Because street lighting is non-excludable, people can benefit without paying, creating a free-rider problem. Private firms cannot earn enough revenue to cover costs, so the market under-supplies or fails to supply it, which justifies government provision or funding through taxation.

  1. AConsumers can easily be charged according to use, so firms overcharge
  2. BFree-riding makes it hard to earn revenue, so private firms under-supply or do not supply itCorrect
  3. CSupply is always too high because marginal cost is zero
  4. DStreet lighting creates only negative externalities
  5. Buyers have asymmetric information about lighting quality

Explanation

With non-excludability people can use the service without paying, so they have an incentive to free-ride. Firms cannot recover costs through prices and therefore under-supply, which is why governments typically provide or fund such goods.

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