Public Goods

A distinguishing feature of public goods is “nonexclusivity,” that is, the marginal cost of accessing public goods is negligible. National defense illustrates this concept. If one offers national defense to an individual, then excluding, say, that individual's next-door neighbor from recognizing associated benefits would indeed be difficult. Because the marginal cost of accessing goods such as national defense is so small, excluding individuals from recognizing the consequent benefits (or costs) can be prohibitively difficult. Such goods are thus referred to as being “public.”

Nonexclusivity makes producing public goods problematic. Continuing the present example, notice that each neighbor has little incentive to contribute to the production of defense. The first neighbor realizes that, because defense is nonexclusive, he or she can consume all of the neighbor's defense and avoid any of the production costs. Recognizing this opportunity to “free ride” off of the neighbor's efforts, the first neighbor will tend to exert less effort toward producing defense than he or she would have if defense was a “private good” (that is, if defense benefits accrued solely to those who contributed to their production).

Nothing is special about the example's first neighbor, however: A symmetric opportunity to free-ride also confronts the second neighbor. As a consequence, each neighbor simultaneously has an incentive to free-ride off the other. Given such incentives, the neighbors may produce no defense jointly, even if each would have produced defense if the associated benefits were exclusive.

Both individuals would be better off contributing to the public good's production, but each is unwilling to do so without a mechanism that precludes the choice of opportunistic actions (that is, actions that increase individual welfare but decrease social welfare). This type of argument is frequently cited to rationalize private and public governance structures. Absent such authorities, individuals are reluctant to expose themselves to the type of opportunism that the defense production example illustrates. As such, they may forgo transactions that, in the presence of an appropriate enforcement mechanism, would be mutually beneficial.

Rules such as patent laws can be understood in this context. Consider, for example, the case of knowledge production. Just as excluding individuals from consuming defense benefits is difficult, so is excluding individuals from consuming benefits that emerge from producing knowledge. Recognizing that knowledge exhibits this property of public goods, individuals have an incentive to free-ride off others' knowledge production. The consequence here, however, parallels that from the defense example; that is, unconstrained individuals produce inferior levels of knowledge.

Institutions such as patent laws can check this difficulty. In effect, patents increase the cost of consuming others' production of knowledge. By “excluding” others from such consumption, patents thus transform what would otherwise be a public good into one that produces sufficient private benefits. To the extent that they make the product of knowledge investments costly to expropriate, patent laws thus facilitate endeavors such as pharmaceutical research and development.