This can be illustrated, where we have depicted a good with
constant
marginal costs of production, c (it costs the firm c dollars
to produce each unit of the good) However, to sell the good entails
transaction costs, which raise the price to p*.
Assume now the
government supplies the good freely. This eliminates the
transaction cost area ABCD and being saved. There is a further
gain in
consumption increases from Q
e
to Q
0‘
since individuals‘
marginal valuations exceeds the marginal cost of production. The
shaded ABE measures the gain. On the other hand,
if individuals
consume the good until the marginal value is equal to zero, in
expanding consumption from Q
0
to Q
m‘
the marginal willingness to
pay is less than the cost of production. This is obviously inefficient.
To decide whether the good
should be provided publicly, we must
compare the savings in transaction
cost plus the gain from
increasing consumption from Q
e
to Q
0
with (1)
the loss from
excessive consumption of the good (the shaded area EFQ
m
), plus
(2) the loss from the distortions created
by any taxes required to
finance the provision of the good publicly.
Three Methods of Rationing Publicly Provided Goods:
Rationing System- Given the inefficiencies arising from over
consumption when no charges are imposed for publicly provided
private goods, government often try to
find some ways of limiting
consumption. These are any method restricting consumption of
goods.
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