Chapter 6 · Market failure and socially undesirable outcomes II: Positive externalities, public goods, asymmetric information and inability to achieve equity
Direct public provision
Show publicly provided output alongside private supply for a good with external benefits. Explain how provision can reduce underconsumption.
The economic idea
Direct provision occurs when government produces or supplies a good or service itself, or finances public institutions that deliver it at zero or subsidised prices. It differs from a subsidy paid to private buyers or sellers.
Merit goods may be underconsumed because consumers underestimate private benefits, cannot afford access or because consumption creates external benefits. Direct provision can address price and availability simultaneously.
In the diagram, government adds a fixed quantity alongside private supply. Total supply increases, the market price falls and total consumption rises. Some private output may be crowded out because consumers substitute toward public provision.
Crowding out is not automatically a policy failure: the relevant comparison is the change in total access, social benefit, quality and real resource cost. Replacing expensive private units can still improve welfare.
The displayed Q* is the pre-policy benchmark from MSB = MSC. Because public and private units are represented as separately using resources, it should be used as a comparison point rather than treated mechanically as the final optimum under every provision design.
Reading provision that expands access but remains below Q*
“Price” is measured vertically and “Quantity” horizontally.
“MPB” represents marginal private benefit and “MSB” marginal social benefit.
“MSC = MPC” represents marginal private cost and “MSC = MPC” marginal social cost.
“S + government provision” shows the intervention currently applied. The shift to the combined provision schedule reflects the fixed public quantity in the model, not a fall in the resource cost of producing every unit.
Before intervention: Eₘ
“Eₘ” is the private-market equilibrium, where “MPB” meets “MSC = MPC”, giving “Pₘ” and “Qₘ”.
Social benchmark: E*
“E*” is where “MSB” meets “MSC = MPC” and gives “Q*”. Because public provision changes the production structure, “Q*” is a pre-policy benchmark rather than automatic proof of the final optimum.
Post-intervention outcome: E₂
Government adds public units alongside private supply, lowering the market price, increasing total consumption and potentially displacing some private output. The resulting outcome is “E₂” at “P₂” and “Q₂”. “Q₂” is above “Qₘ” but remains below “Q*”. The intervention reduces underprovision without eliminating it.
What the intervention changes, and what it does not show
Public provision adds to the availability of the good, represented by “S + government provision”. Goods can be free at the point of use while still requiring workers, buildings and other scarce resources. A zero user price would not mean a zero social cost.
Compare the quantity and quality reaching users with what private providers would otherwise supply. Reaching “Q*” does not by itself prove that the public/private mix is efficient: public resource costs, displacement of private provision and who gains access must also be assessed.
How the direct public provision changes the outcome
The market initially reaches “Eₘ” and “Qₘ” because private decision makers follow “MPB” and “MSC = MPC”.
The social comparison uses “MSB” and “MSC = MPC”, producing the benchmark “E*” and “Q*”.
Government adds public units alongside private supply, lowering the market price, increasing total consumption and potentially displacing some private output.
The new intersection is “E₂” and “Q₂”. “Q₂” is above “Qₘ” but remains below “Q*”. The intervention reduces underprovision without eliminating it. Because public provision changes the production structure, “Q*” is a pre-policy benchmark rather than automatic proof of the final optimum.
What the current state establishes
“Q₂” is above “Qₘ” but remains below “Q*”. The intervention reduces underprovision without eliminating it. Because public provision changes the production structure, “Q*” is a pre-policy benchmark rather than automatic proof of the final optimum.
A rise in activity is not enough to prove success; the remaining gap to Q* represents beneficial units still forgone.
Common mistakes to avoid
- The horizontal increase in total supply should not be described as costless. Public provision uses real resources and has a fiscal opportunity cost.
- The intervention is not automatically optimal because “Q₂” exceeds “Qₘ”. It must be compared with “Q*” and evaluated against its costs.
- Government expenditure is not automatically deadweight loss, but it has an opportunity cost and may require distortionary taxation.
- “Q*” is a pre-policy benchmark in this provision model, not automatic proof that every public/private output mix at that total is efficient.
How to draw this diagram
- Title the diagram “Direct public provision”. Label the horizontal axis “Quantity” and the vertical axis “Price”.
- Draw MPB first and label it clearly.
- Draw MSC = MPC next and label it clearly.
- Draw MSB next and label it clearly.
- Draw S + government provision next and label it clearly.
- Mark each relevant intersection and distinguish the initial, market and socially optimum or policy outcomes where applicable.
- Project important intersections to the axes with dashed guide lines and label the outcomes.
- Check that every symbol used in the explanation appears on the diagram and add arrows showing the direction of change.
Assumptions and limitations
- Public and private services may differ in quality and may not be perfect substitutes as the diagram assumes.
- Capacity constraints, waiting times and rationing can limit effective access even when provision is nominally free.
- The model does not show tax finance, administrative cost or the opportunity cost of public resources.
- Public provision may crowd out private activity, but the welfare meaning depends on total access, quality and cost.
- The pre-policy Q* benchmark may change when the production structure and quality mix change.