AQA A-level Economics: Public goods and externalities (7136) – Revision Notes

These notes condense the AQA AS and A-level Economics specification (version 1.3, 29 June 2022), A-level sub-sections 3.1.8.3 Public goods, private goods and quasi-public goods and 3.1.8.4 Positive and negative externalities in consumption and production (4.1.8.3 and 4.1.8.4 in the combined PDF). For full explanations read the study guide, then test yourself with the practice questions. The hub is AQA A-level Economics, the printable checklist records progress, and the free 10-minute diagnostics find gaps. All figures are invented.

Key terms

Term	Meaning
Rival	Using it leaves less for other people
Excludable	A supplier can stop non-payers using the good
Pure public good	Non-rival and non-excludable
Private good	Rival and excludable
Quasi-public good	Has some public-good features only, so it is partly rival or partly excludable
Common resource	Rival but non-excludable
Free rider	Uses a good without paying
Externality	Cost or benefit to a third party that is not in the price
MPC, MPB	Marginal private cost, marginal private benefit
MSC, MSB	Marginal social cost is MPC plus external cost per unit; marginal social benefit is MPB plus external benefit per unit
Property rights	Legal power to use, exclude others from and sell a resource

Classifying goods

	Excludable	Non-excludable
Rival	Private good	Common resource
Non-rival	Quasi-public (club good)	Pure public good

• Non-excludable means no price can be charged, so private firms do not supply: a missing market.
• Non-rival means the marginal cost of an extra user is zero, so the efficient price is zero.
• Pure public goods are rare. Most real goods are quasi-public.

Public good or private good?

Ask two questions. Could a supplier stop me using it if I do not pay? Does my use leave less for you? Two yeses give a private good; two noes give a pure public good; one of each gives a common resource or a quasi-public good. A good being funded by taxes does not decide its category.

Moving between categories

• Congestion makes a non-rival good rival: a quiet path in the morning, a crowded one at noon.
• Technology can make a good excludable. Broadcasting moved from open signals anyone could pick up to coded signals that only subscribers can decode, so firms can now charge.
• Technology can also make exclusion harder, as with unpaid copying of digital files.
• Always say which characteristic changed and what it means for a supplier’s ability to charge.

Method: finding the efficient output of a public good

1. List each user’s marginal benefit at each quantity.
2. Sum vertically to get marginal social benefit.
3. Compare MSB with marginal cost; the efficient quantity is the last unit where MSB is at least MC.
4. Find what a single user would buy alone, comparing their own marginal benefit with MC.
5. The difference is the under-provision; the welfare loss is the sum of (MSB - MC) on the missing units.

Small worked reminder

Two households value units 1, 2 and 3 of a flood alarm at 10, 6 and 2 (household 1) and 8, 5 and 1 (household 2). MC per unit is 9.

• MSB = 18, 11 and 3.
• Efficient: units 1 and 2 (18 and 11 are at least 9; 3 is not), so 2 units.
• Household 1 alone buys only unit 1 (10 is at least 9; 6 is not). The market gives 1 unit.
• Welfare loss = 11 - 9 = 2.

Free-rider problem

• People can benefit without paying, so each waits for others to pay.
• Revenue falls short of the true value of the good, so it is under-provided or missing.
• It worsens as groups grow bigger and as contributions become harder to observe.
• It is the reason private markets do not supply pure public goods.

Tragedy of the commons

• No owner, so each user disregards the harm done to fellow users.
• Result: over-use and possible exhaustion of a resource.
• Typical environmental cases: fish stocks, forests, clean air, water, the atmosphere.
• The social optimum is where the marginal gain equals marginal cost. Open access stops at the point where the average gain equals cost.

Small worked reminder

On a lake, the total catch from n boats is 20n - 2n². A boat costs 8.

• Open access: average catch 20 - 2n = 8, so n = 6. Catch = 120 - 72 = 48, cost = 48, net = 0.
• Optimum: marginal catch 20 - 4n = 8, so n = 3. Catch = 60 - 18 = 42, cost = 24, net = 18.
• Boats beyond 3 add less than their cost, so they destroy value.

Externalities: the four cases

Case	Curve that moves	Output effect
Negative production	MSC above MPC	Over-production
Negative consumption	MSB below MPB	Over-consumption
Positive production	MSC below MPC	Under-production
Positive consumption	MSB above MPB	Under-consumption

• The market produces where MPB = MPC; the social optimum is where MSB = MSC.
• The welfare loss is the triangle between the relevant curves over the units between the two quantities, with its point at the social optimum.
• Label axes (quantity; price, cost and benefit), both quantities and the triangle.

Small worked reminder: a negative consumption externality

MPB = 29 - 2Q, MPC = MSC = 2 + Q, and the external cost of consumption is 6 per unit, so MSB = 23 - 2Q. Quantity is in thousands.

• Market: 29 - 2Q = 2 + Q, so Q = 9 and P = 11.
• Social: 23 - 2Q = 2 + Q, so Q = 7 and P = 9.
• Over-consumption = 2 thousand. Welfare loss = ½ × 2 × 6 = 6.

Small worked reminder: a positive consumption externality

MPB = 19 - Q, MPC = MSC = 3 + Q, and the external benefit is 4 per unit, so MSB = 23 - Q. Quantity is in thousands.

• Market: 19 - Q = 3 + Q, so Q = 8 and P = 11.
• Social: 23 - Q = 3 + Q, so Q = 10 and P = 13.
• Under-consumption = 2 thousand. Welfare gain from reaching the social output = ½ × 2 × 4 = 4.
• The market ignores the 4 per unit that third parties gain, so it stops too early.

Property rights

• Without rights, no one can charge for use or be made to pay for damage.
• Example chain: no owner of a river, so the polluter pays nothing, so output is too high, so the cost falls on downstream users, so resources are misallocated.
• A sole owner of a resource bears the cost of over-use, so tends to limit use to the efficient level.
• Rights can be hard to define for shared resources and to enforce across borders.

Evaluation checklist

• Are external costs and benefits really measurable, and is the per-unit figure constant?
• Is the good truly pure, or is it quasi-public?
• Could technology or agreed community rules have changed the picture?
• How large is the welfare loss compared with the cost of fixing it?

Quick self-test

1. State the two characteristics of a pure public good.
2. Why does non-excludability create a missing market?
3. Why is the efficient price of a non-rival good zero for an extra user?
4. Name one way technology has made a former public good excludable.
5. With MSB figures of 40, 25 and 8 and MC of 12 per unit, how many units are efficient?
6. A negative production externality shifts which curve, and in which direction?
7. A pond has 3 existing users. A fourth user joins, gaining 10, but each existing user loses 4 as a result. What is the net social effect?
8. For MPB = 20 - 2Q, MPC = 2 + Q and external cost 6, find the market output.
9. Using question 8 with MSC = 8 + Q, find the social output.
10. Why does a positive externality cause under-production?

Answers

1. Non-rival and non-excludable.
2. A supplier cannot stop non-payers, so cannot charge and earn revenue, so no profit-seeking firm supplies it.
3. The extra user does not reduce anyone else’s use, so no extra cost; a price would only exclude users who could benefit at no cost.
4. Coded broadcasting signals, or number-plate cameras on roads.
5. Units 1 and 2 are efficient (40 and 25 are at least 12; 8 is not): 2 units.
6. MSC shifts up (above MPC) by the external cost.
7. The new user gains 10 and imposes 4 on each of 3 others, a loss of 12; the net effect is 10 - 12 = -2. The joiner ignores the 12, which is why open-access users over-use.
8. 20 - 2Q = 2 + Q, so 18 = 3Q and Q = 6.
9. 20 - 2Q = 8 + Q, so 12 = 3Q and Q = 4. (Market output of 6 is 2 above the social output.)
10. The producer or consumer receives only the private benefit and ignores the external benefit, so MSB (or MSC) is not reflected in price and output is below the social optimum.

Where marks are usually lost

• Writing “public goods are provided by government” instead of using rival and excludable.
• Saying the free-rider problem exists without explaining why no one pays.
• Summing public-good demand curves horizontally.
• Putting an external cost on the demand side of a production externality.
• Drawing the diagram without labelling both quantities and the welfare triangle.
• Giving the fishing example without noting that each user ignores the cost to others.
• Stopping at “property rights are absent” without a chain of reasoning to the misallocation.

Official syllabus

AQA AS and A-level Economics specification, version 1.3 (29 June 2022), published by AQA: A-level sub-sections 3.1.8.3 and 3.1.8.4 (4.1.8.3 and 4.1.8.4 in the combined PDF).