Government Expenditure Theories - Public Goods and Merit Goods - What are they and who gets them?

In a free market economy goods and services will only be provided if firms can ensure they will receive payment for them. They will then provide whatever quantity is the most profitable. In doing this, they take account only of the costs and benefits to them. If there are external costs or benefits, they will not take account of these. This may mean that they don't provide the socially optimal level of output. Public goods and merit goods are goods that would either not be provided at all or would not be provided in sufficient quantity, for these reasons.

Public goods

Public goods are goods that would not be provided in a free market system, because firms would not be able to adequately charge for them. This situation arises because public goods have two particular characteristics. They are:

1. Non-excludable - once the goods are provided, it is not possible to exclude people from using them even if they haven't paid. This allows 'free-riders' to consume the good without paying.
2. Non-rival - this means that consumption of the goods by one person does not diminish the amount available for the next person.

We can see this if we look at the case of street lights. If a street light is provided by a firm, then it cannot exclude people from benefiting from it. It is not possible to charge people who walk under it. When people walk under it, it is also true that they don't make it go dimmer - they don't diminish the amount available for the next person. Street lights are therefore non-excludable and non-rival - they are public goods.

Merit goods

Merit goods are goods that would be provided in a free market system, but would almost certainly be under-provided. Take the case of education. If there were no state education provided at all, there would still be private schools for those who could afford them, and indeed many new private schools might open. However, there would not be nearly enough education provided for everyone to benefit. This happens because the market only takes account of the private costs and benefits. It does not take account of the external benefits that may arise to society from everyone being educated. For this reason, merit goods will be under-provided by the market.

If the private sector won't provide these goods in sufficient quantity, then the only way more will be provided is either if the government encourages firms to produce more (perhaps by subsidising the good or service) or if provides them itself. A significant proportion of government expenditure arises from the government providing merit goods. The main examples are:

• Education
• Health
• Fire service