Sometimes, I can enjoy a good without having to pay for it. If my neighbors pay to have a security guard, then I may benefit from that security guard, even though I do not pay. In that case, I am a "free rider," and economists call this the "free-rider problem."

Certain types of goods naturally impose free-rider problems. National defense is an example.

Another example of a public good is environmental quality. With the environment, it is polluters who are "free riders," imposing a cost on others that the polluters themselves do not have to bear. If I drive a high-pollution automobile, the cost of the pollution is spread among everyone in the area in which I drive. If a company dumps toxic waste into a stream, the cost is borne by people downstream.

We could think of pollution as a "public bad," which is the opposite of a public good. However, the more common terminology is to say that pollution is a "negative externality." This term "externality" means an economic consequence that is not taken into account by the producer, because the producer does not absorb the benefit or cost. When the externality imposes a cost, it is a negative externality. When the externality provides a benefit, it is a positive externality. When I was in graduate school, my roommate and I used to pass the factory that made Necco Wafers on the way to class. The smell from the factory was like candy--a positive externality. But we did not have to pay Necco for the pleasure that we got out of walking by the factory.

Not everything that is good for the public is a public good. For example, education is good for the public. However, an individual benefits from his or her own education. Education is only a public good to the extent that I enjoy "free-rider" benefits when you are educated. If individual incentives are sufficient to achieve the optimal production of something, then it is not a public good.

An economic principle known as the Coase Theorem (for Ronald Coase) states that the inefficiencies of public goods can be mitigated when it is possible to clarify property rights. For example, take the case of the company that pollutes a stream. If it is clear who owns the downstream water, then the downstream owner can pay the company to reduce its pollution, or the company can pay the downstream owner for the right to pollute.

The use of property rights to resolve environmental problems can be counter-intuitive. Consider the issue of killing elephants to obtain their tusks for ivory. Some activists have argued that in order to save elephants from extinction, we need to ban ivory. Economists, on the other hand, suggest giving farmers property rights to elephant herds. If I own an elephant herd, then I will want to maximize its long-term value, which means making sure that the herd expands rather than contracts. The argument goes that ownership of elephant herds would ensure the survival of elephants in the same way that the ownership of egg farms ensures that farmers have an incentive to maintain the supply of chickens.

When the problem of a public good or externality cannot be resolved by assigning property rights, only government intervention can mitigate the deadweight loss. For example, the government can regulate pollution or tax polluters. Regulation is like a quota, and a tax is like a tariff.

In the case of national defense, the government provides the public good. Everyone is taxed to help pay for national defense. The government has to decide how much social benefit is provided by national defense, and in theory it should try to maximize the benefits relative to the costs.

Game Theory and Public Goods

Economists use game theory to spell out the problem of public goods. Game theory is the branch of economics in which John Nash ("A Beautiful Mind") earned his Nobel Prize.

Game theory looks at how people will behave when they take into account other people's strategies. A simple example is the payoff matrix for the game known as "prisoner's dilemma." Suppose that a judge has two prisoners that are accused of a crime. The judge tells each prisoner that if one confesses but the other does not, the confessor will serve 1 year, and the other prisoner will serve 10 years. If both confess, they each will serve 5 years. If neither confesses, both will serve three years on a lesser charge. The prisoners will be making their decisions separately in separate hearings.

Here is what the payoff matrix looks like for one of the prisoner, depending on the choice made by the other prisoner.

The problem of congestion on the Beltway at rush hour is like a prisoner's dilemma game. If many drivers would exercise discretion to take trips at off-peak times, everyone might be better off. However, as a driver, taking other drivers' choices as given, my indivudal "payoff matrix" says that I am better off driving at rush hour than moving my trip to a different time.