10 - The scale effect of public goods on production-possibility sets

Abstract

This chapter discusses the shape of the set of production possibilities in the presence of public goods that are inputs to production processes. Examples of such public intermediate goods are the production infrastructure—transport and communications services, irrigation, and flood control, pollution control, and technological knowledge. However, in an economy with non-convexities, existence and Pareto-optimality of competitive equilibrium cannot be assured. The free-rider problem means that in an economy with public goods, Pareto optima may not be attainable. When the public goods are intermediate goods rather than consumption goods, this reason for misallocation of resources loses much of its force because the problem of obtaining the information needed to compute how much public-good supply is optimal and is of lower order of difficulty. If, however, the public intermediate goods give rise to non-convexities in the production-possibility set, then there is a second source of misallocation of resources, separate from the free-rider problem. With non-convexities, even if the public intermediate good is optimally supplied by some mechanism, rational action by individual agents may not lead to an efficient outcome.