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IAI Actuarial Core Principles · Business Economics · Relationship between the government and the individual firm

Street lighting in a town is often provided by the government rather than by private firms. Which characteristic of the good most directly explains why a free market would under-provide it?

A free market would under-provide street lighting because it is non-excludable and non-rival, so people can benefit without paying. This free-rider problem prevents private firms from earning revenue, leading the government to provide it.

  1. AIt is non-excludable and non-rival, creating a free-rider problemCorrect
  2. BIt has high income elasticity of demand
  3. CIt is produced under conditions of perfect competition
  4. DIt has many close substitutes
  5. It is a demerit good whose consumption harms users

Explanation

Street lighting is a public good: once provided, nobody can be excluded and one person's use does not reduce another's. People can free-ride, so private firms cannot collect revenue and supply falls short of the efficient level.

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