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

This guide follows the AQA AS and A-level Economics specification (version 1.3, 29 June 2022). It covers two A-level sub-sections: Public goods, private goods and quasi-public goods, and Positive and negative externalities in consumption and production. The AQA website numbers them 3.1.8.3 and 3.1.8.4; the combined PDF numbers them 4.1.8.3 and 4.1.8.4. Merit and demerit goods, government tools and government failure belong to other units and are not repeated here. All countries, firms and figures below are invented and illustrative. For recall use the revision notes, then test yourself with the practice questions. The hub is AQA A-level Economics, the printable checklist tracks progress, the free 10-minute diagnostics find gaps, and the wider topic guide is Individuals, firms, markets and market failure.

What this unit covers

Specification point	You must be able to
3.1.8.3 Pure public goods	Define non-rival and non-excludable and explain why they matter
Public v private goods	Contrast them using both characteristics
Quasi-public goods	Explain when a public good takes on private-good characteristics
Technological change	Show how it can make a good excludable, for example broadcasting
Free-rider problem	Explain it and link it to non-provision
Tragedy of the commons	Explain it, including its relevance to environmental market failure
3.1.8.4 Externalities	Explain the divergence between private and social costs and benefits
Over- and under-production	Explain why negative externalities cause the first and positive the second
Diagrams	Draw and explain MPC, MSC, MPB and MSB diagrams for production and consumption
Property rights	Explain why their absence leads to externalities and market failure

Pure public goods

A good is non-rival if consuming it leaves just as much for everyone else. It is non-excludable if a supplier cannot stop non-payers from using it. A pure public good is both. Street lighting, flood defences and national defence are standard examples.

	Excludable	Non-excludable
Rival	Private good (a meal)	Common resource (open-sea fish)
Non-rival	Club or quasi-public good (uncongested toll road)	Pure public good (street lighting)

Why each characteristic matters:

• Non-excludability. A firm cannot charge, because people enjoy the good whether or not they pay. Profit-seeking firms will not supply it, so the market is missing.
• Non-rivalry. The marginal cost of one more user is zero. The efficient price for an extra user is therefore zero, and any charge would turn away people who could benefit at no cost to anyone.

A private good is rival and excludable: a price both rations it and pays for it. A public good fails that test, which is why the price mechanism struggles to provide it.

Worked example 1: how much is the efficient amount?

Village X has three households. Their marginal benefit (the most each would pay) from street lamps 1 to 4 is below. The marginal cost of each lamp is 22.

Lamp	Household A	Household B	Household C	Marginal social benefit
1	30	25	20	75
2	20	15	12	47
3	10	8	6	24
4	5	4	2	11

Because the good is non-rival, everyone consumes the same lamps at once, so marginal social benefit is the sum of the individual benefits at each quantity (a vertical sum of the demand curves). Lamps 1 to 3 have a marginal social benefit of at least 22, and lamp 4 does not (11), so the efficient number is 3.

Now suppose provision is left to voluntary payment. Household A values lamp 1 at 30, more than 22, so A would buy it alone. A values lamp 2 at only 20, below 22, so A stops. B and C pay nothing and still enjoy it. The market provides 1 lamp: under-provision of 2. Lamps 2 and 3 add (47 - 22) + (24 - 22) = 25 + 2 = 27 to society’s net benefit, which is lost.

Quasi-public goods and technological change

A quasi-public good has some, but not all, public-good characteristics: it is partly non-rival or partly non-excludable. A good can drift from one position to the other in two ways.

• Congestion makes it rival. An uncongested bridge is non-rival. At rush hour each extra vehicle slows the others.
• Technology makes it excludable. Television broadcasting used to be non-excludable, as anyone with an aerial could watch. Encryption and subscription decoders now let a supplier block non-payers. Cameras that read number plates let a road owner charge for each journey. Once a firm can exclude, it can charge, so a profit-seeking supplier may now find it worthwhile.

The change is not always one way. Technology can also make exclusion harder, such as copying digital files without payment. Strictly pure public goods are rare; most real cases are quasi-public and sit on a spectrum.

The free-rider problem

A free rider consumes a good without paying because others’ payment (or the supplier’s inability to charge) means they cannot be stopped. If enough people reason this way, no one pays, revenue is zero and a good with large total benefit is under-provided or not provided at all. In example 1, three households together value lamp 1 at 75, yet no one will fund the 22 cost beyond lamp 1 because each hopes another will pay.

The problem is greatest when groups are large and anonymous, since a single person’s contribution seems unimportant and non-payers are hard to identify.

The tragedy of the commons

A common resource is rival but non-excludable, such as an open fishing ground, common grazing land or the atmosphere. No one owns it, so each user disregards the harm their own use does to the other users. Each takes more than the group would choose, and the resource is over-used or destroyed. This is the tragedy of the commons, and it is the reason many environmental market failures occur: fish stocks, forests, clean air and water.

Worked example 2: an open fishing ground

On Sea Z, total catch (tonnes, each worth 1 unit) from n boats is 30n - 2n². Each boat costs 10 a season. Open access means boats enter while the average catch covers the cost.

• Average catch per boat = 30 - 2n. Entry stops when 30 - 2n = 10, so n = 10 boats.
• At n = 10: catch = 300 - 200 = 100, cost = 100, net gain = 0.
• Social optimum: add a boat while the extra catch is at least its cost. Marginal catch = 30 - 4n = 10, so n = 5.
• At n = 5: catch = 150 - 50 = 100, cost = 50, net gain = 50.

Ten boats land the same 100 as five, at double the cost. Each new boat gains the average catch but ignores the fall it causes in everyone else’s catch, so the private gain exceeds the social gain. A single owner of the whole fishery would choose 5 boats, which links directly to property rights below.

Externalities (3.1.8.4)

An externality is a cost or benefit to a third party, outside the transaction, that is not reflected in the price. Externalities exist when there is a divergence between private and social costs and benefits:

• MSC (marginal social cost) is MPC (marginal private cost) plus the external cost of one more unit.
• MSB (marginal social benefit) is MPB (marginal private benefit) plus the external benefit of one more unit.

Free markets follow private incentives, so output is set where MPB = MPC. Efficiency requires MSB = MSC.

Type	Example	Divergence	Result
Negative, production	Factory pollution	MSC above MPC	Over-production
Negative, consumption	Loud music from a car	MSB below MPB	Over-consumption
Positive, production	Orchard blossom feeding a neighbour’s bees	MSC below MPC	Under-production
Positive, consumption	Fitting a smoke alarm in a shared stair	MSB above MPB	Under-consumption

Draw with quantity on the horizontal axis and price and cost on the vertical axis. For a negative production externality: MPC and MSC both slope upwards, with MSC above MPC by the external cost; MPB slopes downwards. The market equilibrium is where MPB crosses MPC. The social optimum is where MPB crosses MSC, at a lower quantity and higher price. The area between MSC and MPB over the units between the two quantities is the welfare loss.

Worked example 3: a negative production externality

A paint plant in Country A (invented). Quantity is in thousands of units, prices in £ per unit. MPB = 24 - 2Q, MPC = 4 + 2Q, and the external cost is 6 per unit, so MSC = 10 + 2Q.

Q	MPB	MPC	MSC
1	22	6	12
3	18	10	16
5	14	14	20
7	10	18	24

• Market: 24 - 2Q = 4 + 2Q, so Q = 5 and P = 14.
• Social optimum: 24 - 2Q = 10 + 2Q, so Q = 3.5 and P = 17.
• Over-production = 5 - 3.5 = 1.5 thousand units.
• Welfare loss = ½ × 1.5 × (MSC - MPB at Q = 5) = ½ × 1.5 × (20 - 14) = 4.5, which is £4,500.

At Q = 5 the external cost of 6 per unit is unpaid by the producer. For the units from 3.5 to 5, society values the extra output at less than the full cost of making it, so output is too high.

Worked example 4: a positive production externality

A beekeeper’s neighbouring orchard (invented). MPB = 41 - 3Q, MPC = 11 + 2Q, and each unit of fruit creates an external benefit of 10, so MSC = 1 + 2Q.

• Market: 41 - 3Q = 11 + 2Q, so Q = 6 and P = 23.
• Social optimum: 41 - 3Q = 1 + 2Q, so Q = 8 and P = 17.
• Under-production = 2. Welfare gain from correcting it = ½ × 2 × 10 = 10.

The orchard owner is not paid for the benefit to the beekeeper, so the orchard supplies too little. For a positive consumption externality the MSB curve lies above MPB and the same logic applies on the demand side.

Property rights

Property rights give an owner the legal power to use a resource, exclude others and sell it. Where they are missing or cannot be enforced, no one can charge for the use of a resource or be made to pay for damage. A river with no owner is a clear case. A factory discharging into it faces no cost, so the cost falls on downstream users: a production externality. A grazing common or fishery with no owner gives a consumption-side version, as users cannot be stopped and so ignore costs they impose. Without rights, no market exists to price the damage or the benefit, so resources are misallocated. In example 2 an owner would restrict boats to 5 because the owner bears the cost of over-fishing. Rights are not always easy to define or enforce, particularly for air, oceans and wildlife that cross borders.

Evaluation points

• Measuring external costs and benefits is difficult, and the constant-per-unit assumption in the examples simplifies reality.
• Pure public goods are rare; many goods are quasi-public, and technology keeps changing their status.
• Free-riding may be overstated: people donate to charities and community projects, and some communities have managed commons through agreed rules.
• Where an externality is small, the cost of correcting it may exceed the welfare gain.
• The scale of a tragedy of the commons depends on the number of users and how hard the resource is to monitor.

Common errors

• Defining non-rival as “cannot be used up”: it means one more user does not reduce others’ use.
• Calling any government-provided good a public good. Classify by the two characteristics.
• Adding the public-good demand curves horizontally. They are summed vertically.
• Putting the external cost on the wrong curve: negative production moves MSC, not MPB.
• Shading the welfare loss from zero rather than between the market and social outputs.
• Describing the problem without saying who the third party is.

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 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).