THEORY OF SOCIAL GOODS

It is general view that only price mechanism can bring about best utilization of economic resources, but this view has been validated empirically in case of private goods only. The goods which are rival in consumption and exclusion of non paying users by the owner feasible. Market economy, however , fails in efficient allocation of scarce resources in the following situations:

• The goods which are non rival in consumption 
• The good whose production or consumption generates non marketable external effects- known as externalities
• The goods which are produced under decreasing cost technology

If a good is non rival in consumption and exclusion is not desirable or impracticable, it is called pure public goods like national defense and flood control, its provision is possible in the free market provided the number of its consumer is small and each of them reveal his true preferences.

At equilibrium, each person would consume the same amount but would pay differently according to his revealed preferences , such that the sum of individual payments equals marginal cost : However when the number of consumer is large each of them would have an incentive to understate its true preferences so that he has to pay less. It is known as "free rider problem". Free market cannot succeed, in this case. Hence budgetary provision is demanded for.

In order to know the true preferences of each beneficiary government usually adopt voting system, whether to provide the particular good with a given tax liability for all or not. Government take up the majority decision so each individual is expected not to understate his true preferences lest the desired goods is not provided at all.

So far, we categorized goods with individualistic point of view and neglected societal point of view. It is quite possible that a commodity or economic activity is a good for an individual but a bad for the society as a whole. Like, liquor, theft and bribery etc such a commodity is called a merit good. It needs special treatment different from public and private goods.

The decreasing coast industries are nationalized and called natural monopolies like airlines and railway. The marginal cost pricing principle which completely fails in this case is replaced by average cost/markup pricing principle.