Question

Describe how total market demand for private and public goods are derived. Explain why these two types of demand curves are derived differently. The use of diagrams will make this question easier to answer.

Answer 1

Total market demand for private and public goods are derived differently as

Public goods are non-excludable and non-rival. Individuals cannot be effectively excluded from using them, and use by one individual does not reduce the good’s availability to others. Examples of public goods include the air we breathe, public parks, and street lights, national defence, flood control systems etc. Public goods may give rise to the “free rider problem. ” A free-rider is a person who receives the benefit of a good without paying for it. Where as Private goods are excludable and rival. Examples of private goods include food, clothes, and flowers etc. There are usually limited quantities of these goods, and owners or sellers can prevent other individuals from enjoying their benefits. Because of their relative scarcity, many private goods are exchanged for payment.

The market demand for private goods is derived through the horizontal summation of individual demand curves. However, the market demand for public goods is derived through the vertical summation of individual demand curves. For private goods, the market demand will answer the question “What is the total quantity that buyers would be willing to purchase at given price?” while for public goods, the market demand will answer this question “what is the total value or benefit generated from consuming a given quantity?”

The Market Demand for Private Goods

     To see the difference between private and public goods, first consider the market demand for private goods. The primary focus of the market demand for private goods is on the price that the buyers pay. The total market demand is derived by adding up or summing the quantity demanded by every buyer at a given price. For example, the market demand for stuffed animals. This particular market contains only two buyers, Martin and Andrew. Suppose that Martin is willing and able to purchase 2 stuffed animals at a $1 price and Andrew is willing and able to purchase 6 stuffed animals at this price. In this case, the total market demand at the $1 price is 8 stuffed animals which is 2 + 6. The market demand curve is then derived by identifying the quantities that these two buyers would be willing and able to purchase at different prices.

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      The market demand is the horizontal summation of the individual demand curves of Martin and Andrew. The quantities are horizontally summed for a given price. The resulting red demand curve is the market demand for stuffed animal.

The Market Demand for Public Goods

      Non-rivalrous consumption makes the derivation of the demand for public goods a different story. Everyone can enjoy the benefits of a public good simultaneously. The consumption by one person does not prevent the consumption by another. As such, the value society receives from a public good is the sum of the value received by all who enjoy the benefits. This means that the demand for public goods is based on the vertical summation of individual demand curves.

      For example let's return to our two buyers, Martin and Andrew. However, in this case they are consuming a public good, such as national defence. The focus of attention is now on the price each buyer would be willing to pay for a given quantity of the good let’s say 2 fighter jets. Suppose that Martin is willing and able to pay $1 for a given level of defence and Andrew is willing and able to pay $3 for this level. The total market demand is the sum of the prices that each is willing to pay, which is $4 ($1 + $3). The market demand curve is then derived by summing the prices that these two buyers would be willing and able to pay for different quantities.

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The market demand curve is the vertical summation of the individual demand curves of Martin and Andrew. The prices are vertically summed for a given quantity. This new red demand curve labelled D is now the market demand for the public good.

The conclusion of these private and public goods is that the difference is subtle, but key to an understanding of public goods. Efficiency dictates that the extra benefit generated by a good is equal to the extra opportunity cost of production which meant the marginal benefit generated from the production of one more unit of the good is equal to the marginal cost of production. Furthermore, because private goods are rivalrous in consumption, the production of one more unit of the good can be consumed only by one person. Efficiency is then achieved when the extra benefit received by that one person is equal to the extra cost of production. On the other hand, it is a different for public goods that are non-rivalrous in consumption. This is because public goods are consumed by everyone simultaneously and the extra benefit derived from consumption is the extra benefit by everyone combined. This can be obtained by summing the extra benefit that each receives, which meant by summing the price each is willing to pay.