There are, finally, undoubted fields where no legal arrangements can create the main condition on which the usefulness of the system of competition and private property depends: namely, that the owner benefits from all the useful services rendered by his property and suffers for all the damages caused to others by its use. Where, for example, it is impracticable to make the enjoyment of certain services dependent on the payment of a price, competition will not produce the services; and the price system becomes similarly ineffective when the damage caused to others by certain uses of property cannot be effectively charged to the owner of that property. In all these instances there is a divergence between the items which enter into private calculation and those which affect social welfare; and, whenever this divergence becomes important, some method other than competition may have to be found to supply the services in question. Thus neither the provision of signposts on the roads nor, in most circumstances, that of the roads themselves can be paid for by every individual user. Nor can certain harmful effects of deforestation, of some methods of farming, or of the smoke and noise of factories be confined to the owner of the property in question or to those who are willing to submit to the damage for an agreed compensation. In such instances we must find some substitute for the regulation by the price mechanism. But the fact that we have to resort to the substitution of direct regulation by authority where the conditions for the proper working of competition cannot be created does not prove that we should suppress competition where it can be made to function.
Hayek says in this passage that certain goods are not functions of the normal supply and demand functions, so the cost to produce them or the benefits of production do not make economic sense to be produced, yet are necessary to the society. Examples of such things are military defense, as one cannot price the level of defense an individual needs since the state's defense encompasses all who live in it, regardless of their contribution. In other words, marginal benefit(MB) of the first user is the same as the second, is the same as the third, etc. The example in the passage about pollution from logging is an example of an externality(which shall be covered later) but clean air and water are public goods. Some public goods arise out of necessity to life, such as waterm and cannot be very effectively priced. If water were effectively priced based on market conditions, the resulting cost(people dying of dehydration and disrorder) would be far greater than the private benefit (profits for the water provider). In other words in a public good the social benefit(the benefit to society) outweighs the private benefit (benefit to the individual) and the marginal benefits to society are greater than the marginal benefits to the private individual.
Further, a true public good has two key characteristics--non rivalrous and non exclusionary. That means that a public good does not have competition and cannot have the benefit to one individual reduced by enjoyment of another(why MB is the same regardless of the number of consumers). At the opposite end of the spectrum are exclusive and rivalrous good-- private goods-- which result in private benefit being much greater than social benefit. A home is a private good because the enjoyment of the home for the owner is of greater benefit than the marginal benefit of having strangers also inhabit the home, which reduces the benefit for the individual. Most goods are closer to the pure private good end of the spectrum.
Are schools public goods is an often argued question in public policy classes. Here at the Invisible Boot we exam the question based on the characteristics of a public good. Let us go through a list of characteristics to examine.
1)Are public schools nonrivalrous(no substitute)?- No, they have competition from charter schools and private schools
2)Are they non exclusionary- No, the geographic boundaries of schools means that lower income students are excluded from wealthier schools with larger budgets, so the benefit to each user is not equal.
3) Is marginal benefit the same regardless of the number of users- No, the more users a school has, the lower the benefits due to reduced attention to each student a teach gives, and the scale of the school causes inefficiency in allocating resources as the volume of students creates more problems with management relative to the increase in money from each new student.
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