A public good is a product or service that has two distinct characteristics: 1) it is impossible or inefficient to exclude individuals from using or consuming it and 2) addition of users does not reduce the availability of the product or service.
For example, a lighthouse provides light to all ships which travel within its vicinity. The lighthouse cannot prevent or exclude certain ships from receiving light; it gives off light to all ships, regardless of whether they contribute funds to maintain operations of the lighthouse. Similarly, even if the number of ships near the lighthouse increases from 5-10, the amount of “available” light is not decreased, but instead remains constant.
Other common examples of public goods include clean air, national defense, police and fire protection, and fireworks.
Public goods typically must be provided in equal quantities to all users, and because of these characteristics, the provision of public goods is associated with the “free rider problem.” The free rider problem occurs when consumers do not pay their share of the costs for the production of a good or service (or consumes more than their fair share).
If one neighbor in a community reduces his or her individual pollution, all of the members of the community will benefit from the reduction. Some neighbors may consciously choose to keep polluting, thinking that others will reduce their pollution. If everyone operates under this assumption, everyone will pollute and air quality will be degraded. No one will have an incentive to reduce pollution.
The free rider problem can result in underproduction of a service or degradation of quality through over use. Why create a product, if your customers don’t have to pay you to use it?
For much of economic history, economists believed that no decentralized pricing system could optimally determine the level of consumption for public goods, arguing that it was impossible to develop a system in which individuals would truthfully reveal their preferences (costs/benefits). However, in the 1970s a revolution took place when economists like Ed Clarke (1971, 1972) began to develop and apply demand revealing mechanisms to the problem of public goods.