ICAI Notes- Unit 2: Market Failure/ Government intervention to correct Market Failure | Business Economics for CA Foundation PDF Download

 Page 1


 1.23 
 
 
 7.23 
PUBLIC FINANCE 
LEARNING OUTCOMES 
UNIT – 2: MARKET FAILURE/ 
GOVERNMENT INTERVENTION TO 
CORRECT MARKET FAILURE 
 
 
 
 
After studying this unit, you will be able to – 
• Define the concept of market failure 
• Describe the different sources of market failure 
• Explain various government interventions for correcting market 
failure 
 
 
 
2.1 INTRODUCTION  
The market is an environment where buyers and sellers transact or exchange goods and 
services. Economists presume that people will make choices in their own self-interest. They 
will choose those things that provide the greatest personal benefit, and keep themselves away 
from those that are not valuable and worth seeking. In other words, individuals will behave 
rationally. 
The general belief is that since rational individuals act to maximise self interest, a perfectly 
working market system is, by default, efficient and will effectively allocate scarce economic 
resources in the best possible manner. In other words, in a well functioning market, prices 
provide the accurate signals to producers and consumers and the right quantity of whatever 
consumers choose to consume will be produced and supplied at the right price. However, this 
is not always true. Under certain circumstances, ‘market failure’ occurs, i.e. the market fails to 
allocate resources efficiently and therefore, market outcomes become inefficient. 
CHAPTER OVERVIEW 
 
© The Institute of Chartered Accountants of India
Page 2


 1.23 
 
 
 7.23 
PUBLIC FINANCE 
LEARNING OUTCOMES 
UNIT – 2: MARKET FAILURE/ 
GOVERNMENT INTERVENTION TO 
CORRECT MARKET FAILURE 
 
 
 
 
After studying this unit, you will be able to – 
• Define the concept of market failure 
• Describe the different sources of market failure 
• Explain various government interventions for correcting market 
failure 
 
 
 
2.1 INTRODUCTION  
The market is an environment where buyers and sellers transact or exchange goods and 
services. Economists presume that people will make choices in their own self-interest. They 
will choose those things that provide the greatest personal benefit, and keep themselves away 
from those that are not valuable and worth seeking. In other words, individuals will behave 
rationally. 
The general belief is that since rational individuals act to maximise self interest, a perfectly 
working market system is, by default, efficient and will effectively allocate scarce economic 
resources in the best possible manner. In other words, in a well functioning market, prices 
provide the accurate signals to producers and consumers and the right quantity of whatever 
consumers choose to consume will be produced and supplied at the right price. However, this 
is not always true. Under certain circumstances, ‘market failure’ occurs, i.e. the market fails to 
allocate resources efficiently and therefore, market outcomes become inefficient. 
CHAPTER OVERVIEW 
 
© The Institute of Chartered Accountants of India
1.  
  
BUSINESS ECONOMICS 
 
 7.24 
2.2  THE CONCEPT OF MARKET FAILURE 
The inefficient allocation of resources in an economy is described as market failure. The term 
“market failure” does not mean the market is not working at all, it only means that the market 
does not function in the way that it should.  Market failure is a situation in which the free 
market leads to misallocation of society's scarce resources in the sense that there is either 
overproduction or underproduction of particular goods and services leading to a less than 
optimal outcome. There are two types of market failure namely;  
1. Complete market failure. This is a case of "missing markets" and occurs when the 
market does not supply products at all despite the fact that such products and services 
are wanted by people. E.g. Pure public goods. 
2. Partial market failure occurs when the market does actually function, but it produces 
either the wrong quantity of a product or at the wrong price. This results in loss of 
economic welfare.  
2.3 WHY DO MARKETS FAIL? 
The pertinent question here is why do markets fail? Or why do markets fail to produce the 
ideal outcome that economic theory predicts? Perfectly competitive markets will generate 
outcomes in which the economy’s resources are allocated to their ‘highest val ued uses’ and 
no one person can be made better off without making at least another person worse off.   
Though perfectly competitive markets work efficiently, in the real world, conditions necessary 
for efficient outcome namely, perfect competition is not practical. We know that conditions 
such as large number of small firms, perfect knowledge, homogenous products etc. are not 
generally present in most markets. We shall first try to understand why markets fail and then 
proceed to identify the role of government in dealing with market failure. 
There are four major reasons for market failure. They are: 
• Market power, 
• Externalities, 
• Public goods, and 
• Incomplete information 
We shall discuss each of the above in detail. 
  
© The Institute of Chartered Accountants of India
Page 3


 1.23 
 
 
 7.23 
PUBLIC FINANCE 
LEARNING OUTCOMES 
UNIT – 2: MARKET FAILURE/ 
GOVERNMENT INTERVENTION TO 
CORRECT MARKET FAILURE 
 
 
 
 
After studying this unit, you will be able to – 
• Define the concept of market failure 
• Describe the different sources of market failure 
• Explain various government interventions for correcting market 
failure 
 
 
 
2.1 INTRODUCTION  
The market is an environment where buyers and sellers transact or exchange goods and 
services. Economists presume that people will make choices in their own self-interest. They 
will choose those things that provide the greatest personal benefit, and keep themselves away 
from those that are not valuable and worth seeking. In other words, individuals will behave 
rationally. 
The general belief is that since rational individuals act to maximise self interest, a perfectly 
working market system is, by default, efficient and will effectively allocate scarce economic 
resources in the best possible manner. In other words, in a well functioning market, prices 
provide the accurate signals to producers and consumers and the right quantity of whatever 
consumers choose to consume will be produced and supplied at the right price. However, this 
is not always true. Under certain circumstances, ‘market failure’ occurs, i.e. the market fails to 
allocate resources efficiently and therefore, market outcomes become inefficient. 
CHAPTER OVERVIEW 
 
© The Institute of Chartered Accountants of India
1.  
  
BUSINESS ECONOMICS 
 
 7.24 
2.2  THE CONCEPT OF MARKET FAILURE 
The inefficient allocation of resources in an economy is described as market failure. The term 
“market failure” does not mean the market is not working at all, it only means that the market 
does not function in the way that it should.  Market failure is a situation in which the free 
market leads to misallocation of society's scarce resources in the sense that there is either 
overproduction or underproduction of particular goods and services leading to a less than 
optimal outcome. There are two types of market failure namely;  
1. Complete market failure. This is a case of "missing markets" and occurs when the 
market does not supply products at all despite the fact that such products and services 
are wanted by people. E.g. Pure public goods. 
2. Partial market failure occurs when the market does actually function, but it produces 
either the wrong quantity of a product or at the wrong price. This results in loss of 
economic welfare.  
2.3 WHY DO MARKETS FAIL? 
The pertinent question here is why do markets fail? Or why do markets fail to produce the 
ideal outcome that economic theory predicts? Perfectly competitive markets will generate 
outcomes in which the economy’s resources are allocated to their ‘highest val ued uses’ and 
no one person can be made better off without making at least another person worse off.   
Though perfectly competitive markets work efficiently, in the real world, conditions necessary 
for efficient outcome namely, perfect competition is not practical. We know that conditions 
such as large number of small firms, perfect knowledge, homogenous products etc. are not 
generally present in most markets. We shall first try to understand why markets fail and then 
proceed to identify the role of government in dealing with market failure. 
There are four major reasons for market failure. They are: 
• Market power, 
• Externalities, 
• Public goods, and 
• Incomplete information 
We shall discuss each of the above in detail. 
  
© The Institute of Chartered Accountants of India
 1.25 
 
 
 7.25 
PUBLIC FINANCE 
2.3.1 Market Power 
Market power or monopoly power is the ability of a firm to profitably raise the market price 
of a good or service over its marginal cost. Firms that have market power are price makers 
and therefore, can charge a price that gives them positive economic profits. Excessive market 
power causes the single producer or a small number of producers to restrict output (i.e 
produce and sell less output than would be produced in a competitive market) and charge 
price higher than what would prevail under perfect competition. These profits are not achieved 
due to operating efficiency, but due to market power and dominance. Thus, market fails to 
produce the right quantity of goods and services at the right price.  
2.3.2 Externalities 
We begin by describing externalities and then proceed to discuss how they create market 
inefficiencies. As we are aware, anything that one individual does, may have, at the margin, 
some effect on others. For example, if individuals decide to switch from consumption of 
ordinary vegetables to consumption of organic vegetables, they would, other things equal, 
increase the price of organic vegetables and potentially reduce the welfare of existing 
consumers of organic vegetables. However, we should note that all these operate through 
price mechanism i.e. through changes in prices. The price system works efficiently because 
market prices convey information to both producers and consumers. However, when a 
consumption or production activity has an indirect effect (either positive or negative) on 
consumption or production activities of others and such effects are not reflected directly in 
market prices, we call it an externality.  
Externalities are costs (negative externalities) or benefits (positive externalities), which are not 
reflected in free market prices. They are called externalities because they are “external” to the 
market. Externalities are also referred to as 'spillover effects', 'neighbourhood effects' 'third-
party effects' or 'side-effects', as the originator of the externality imposes costs or benefits on 
others who are not responsible for initiating the effect. Since it occurs outside the price 
mechanism, it has not been compensated for, or in other words it is uninternalized or the cost 
(benefit) of it is not borne (paid) by the parties. 
Externalities can be positive or negative. Negative externalities occur when the action of one 
party imposes costs on another party. Positive externalities occur when the action of one party 
confers benefits on another party.  
Production Externalities 
A negative production externality initiated in production which imposes an external cost on 
others may be received by another in consumption or in production. As an example,  
© The Institute of Chartered Accountants of India
Page 4


 1.23 
 
 
 7.23 
PUBLIC FINANCE 
LEARNING OUTCOMES 
UNIT – 2: MARKET FAILURE/ 
GOVERNMENT INTERVENTION TO 
CORRECT MARKET FAILURE 
 
 
 
 
After studying this unit, you will be able to – 
• Define the concept of market failure 
• Describe the different sources of market failure 
• Explain various government interventions for correcting market 
failure 
 
 
 
2.1 INTRODUCTION  
The market is an environment where buyers and sellers transact or exchange goods and 
services. Economists presume that people will make choices in their own self-interest. They 
will choose those things that provide the greatest personal benefit, and keep themselves away 
from those that are not valuable and worth seeking. In other words, individuals will behave 
rationally. 
The general belief is that since rational individuals act to maximise self interest, a perfectly 
working market system is, by default, efficient and will effectively allocate scarce economic 
resources in the best possible manner. In other words, in a well functioning market, prices 
provide the accurate signals to producers and consumers and the right quantity of whatever 
consumers choose to consume will be produced and supplied at the right price. However, this 
is not always true. Under certain circumstances, ‘market failure’ occurs, i.e. the market fails to 
allocate resources efficiently and therefore, market outcomes become inefficient. 
CHAPTER OVERVIEW 
 
© The Institute of Chartered Accountants of India
1.  
  
BUSINESS ECONOMICS 
 
 7.24 
2.2  THE CONCEPT OF MARKET FAILURE 
The inefficient allocation of resources in an economy is described as market failure. The term 
“market failure” does not mean the market is not working at all, it only means that the market 
does not function in the way that it should.  Market failure is a situation in which the free 
market leads to misallocation of society's scarce resources in the sense that there is either 
overproduction or underproduction of particular goods and services leading to a less than 
optimal outcome. There are two types of market failure namely;  
1. Complete market failure. This is a case of "missing markets" and occurs when the 
market does not supply products at all despite the fact that such products and services 
are wanted by people. E.g. Pure public goods. 
2. Partial market failure occurs when the market does actually function, but it produces 
either the wrong quantity of a product or at the wrong price. This results in loss of 
economic welfare.  
2.3 WHY DO MARKETS FAIL? 
The pertinent question here is why do markets fail? Or why do markets fail to produce the 
ideal outcome that economic theory predicts? Perfectly competitive markets will generate 
outcomes in which the economy’s resources are allocated to their ‘highest val ued uses’ and 
no one person can be made better off without making at least another person worse off.   
Though perfectly competitive markets work efficiently, in the real world, conditions necessary 
for efficient outcome namely, perfect competition is not practical. We know that conditions 
such as large number of small firms, perfect knowledge, homogenous products etc. are not 
generally present in most markets. We shall first try to understand why markets fail and then 
proceed to identify the role of government in dealing with market failure. 
There are four major reasons for market failure. They are: 
• Market power, 
• Externalities, 
• Public goods, and 
• Incomplete information 
We shall discuss each of the above in detail. 
  
© The Institute of Chartered Accountants of India
 1.25 
 
 
 7.25 
PUBLIC FINANCE 
2.3.1 Market Power 
Market power or monopoly power is the ability of a firm to profitably raise the market price 
of a good or service over its marginal cost. Firms that have market power are price makers 
and therefore, can charge a price that gives them positive economic profits. Excessive market 
power causes the single producer or a small number of producers to restrict output (i.e 
produce and sell less output than would be produced in a competitive market) and charge 
price higher than what would prevail under perfect competition. These profits are not achieved 
due to operating efficiency, but due to market power and dominance. Thus, market fails to 
produce the right quantity of goods and services at the right price.  
2.3.2 Externalities 
We begin by describing externalities and then proceed to discuss how they create market 
inefficiencies. As we are aware, anything that one individual does, may have, at the margin, 
some effect on others. For example, if individuals decide to switch from consumption of 
ordinary vegetables to consumption of organic vegetables, they would, other things equal, 
increase the price of organic vegetables and potentially reduce the welfare of existing 
consumers of organic vegetables. However, we should note that all these operate through 
price mechanism i.e. through changes in prices. The price system works efficiently because 
market prices convey information to both producers and consumers. However, when a 
consumption or production activity has an indirect effect (either positive or negative) on 
consumption or production activities of others and such effects are not reflected directly in 
market prices, we call it an externality.  
Externalities are costs (negative externalities) or benefits (positive externalities), which are not 
reflected in free market prices. They are called externalities because they are “external” to the 
market. Externalities are also referred to as 'spillover effects', 'neighbourhood effects' 'third-
party effects' or 'side-effects', as the originator of the externality imposes costs or benefits on 
others who are not responsible for initiating the effect. Since it occurs outside the price 
mechanism, it has not been compensated for, or in other words it is uninternalized or the cost 
(benefit) of it is not borne (paid) by the parties. 
Externalities can be positive or negative. Negative externalities occur when the action of one 
party imposes costs on another party. Positive externalities occur when the action of one party 
confers benefits on another party.  
Production Externalities 
A negative production externality initiated in production which imposes an external cost on 
others may be received by another in consumption or in production. As an example,  
© The Institute of Chartered Accountants of India
1.  
  
BUSINESS ECONOMICS 
 
 7.26 
• A negative production externality is received in consumption when a factory which 
produces aluminium discharges untreated waste water into a nearby river and pollutes 
the water causing health hazards for people who use the water for drinking and 
bathing. 
• A negative production externality is received in production when pollution of river 
affects fish output as there will be less catch for fishermen due to loss of fish resources.  
The firm, however, has no incentive to account for the external costs that it imposes on 
consumers of river water or on fishermen when making its production decision. Additionally, 
these external costs are never reflected in the price of the product. 
A positive production externality initiated in production that confers external benefits on 
others may be received in production or in consumption. 
• A firm which offers training to its employees for increasing their skills generates 
positive benefits on other firms when they hire such workers as they change their jobs.  
• A positive production externality is received in consumption when an individual raises 
an attractive garden and the persons walking by enjoy the garden. These external 
effects were not in fact taken into account when the production decisions were made. 
Consumption Externalities 
Negative consumption externalities initiated in consumption which produce external costs on 
others may be received in consumption or in production.  
• smoking cigarettes in public place causing passive smoking by others, creating litter 
and diminishing the aesthetic value of the room and playing the radio loudly 
obstructing one from enjoying a concert are examples of negative consumption 
externalities affecting consumption 
• The act of undisciplined students talking and creating disturbance in a class preventing 
teachers from making effective instruction and the case of excessive consumption of 
alcohol causing impairment in efficiency for work and production are instances of 
negative consumption externalities affecting production. 
A positive consumption externality initiated in consumption that confers external benefits on 
others may be received in consumption or in production.  
• if people get immunized against contagious diseases, they would confer a social 
benefit to others as well by preventing others from getting infected.  
• Consumption of the services of a health club by the employees of a firm would result 
in an external benefit to the firm in the form of increased efficiency and productivity.  
 
© The Institute of Chartered Accountants of India
Page 5


 1.23 
 
 
 7.23 
PUBLIC FINANCE 
LEARNING OUTCOMES 
UNIT – 2: MARKET FAILURE/ 
GOVERNMENT INTERVENTION TO 
CORRECT MARKET FAILURE 
 
 
 
 
After studying this unit, you will be able to – 
• Define the concept of market failure 
• Describe the different sources of market failure 
• Explain various government interventions for correcting market 
failure 
 
 
 
2.1 INTRODUCTION  
The market is an environment where buyers and sellers transact or exchange goods and 
services. Economists presume that people will make choices in their own self-interest. They 
will choose those things that provide the greatest personal benefit, and keep themselves away 
from those that are not valuable and worth seeking. In other words, individuals will behave 
rationally. 
The general belief is that since rational individuals act to maximise self interest, a perfectly 
working market system is, by default, efficient and will effectively allocate scarce economic 
resources in the best possible manner. In other words, in a well functioning market, prices 
provide the accurate signals to producers and consumers and the right quantity of whatever 
consumers choose to consume will be produced and supplied at the right price. However, this 
is not always true. Under certain circumstances, ‘market failure’ occurs, i.e. the market fails to 
allocate resources efficiently and therefore, market outcomes become inefficient. 
CHAPTER OVERVIEW 
 
© The Institute of Chartered Accountants of India
1.  
  
BUSINESS ECONOMICS 
 
 7.24 
2.2  THE CONCEPT OF MARKET FAILURE 
The inefficient allocation of resources in an economy is described as market failure. The term 
“market failure” does not mean the market is not working at all, it only means that the market 
does not function in the way that it should.  Market failure is a situation in which the free 
market leads to misallocation of society's scarce resources in the sense that there is either 
overproduction or underproduction of particular goods and services leading to a less than 
optimal outcome. There are two types of market failure namely;  
1. Complete market failure. This is a case of "missing markets" and occurs when the 
market does not supply products at all despite the fact that such products and services 
are wanted by people. E.g. Pure public goods. 
2. Partial market failure occurs when the market does actually function, but it produces 
either the wrong quantity of a product or at the wrong price. This results in loss of 
economic welfare.  
2.3 WHY DO MARKETS FAIL? 
The pertinent question here is why do markets fail? Or why do markets fail to produce the 
ideal outcome that economic theory predicts? Perfectly competitive markets will generate 
outcomes in which the economy’s resources are allocated to their ‘highest val ued uses’ and 
no one person can be made better off without making at least another person worse off.   
Though perfectly competitive markets work efficiently, in the real world, conditions necessary 
for efficient outcome namely, perfect competition is not practical. We know that conditions 
such as large number of small firms, perfect knowledge, homogenous products etc. are not 
generally present in most markets. We shall first try to understand why markets fail and then 
proceed to identify the role of government in dealing with market failure. 
There are four major reasons for market failure. They are: 
• Market power, 
• Externalities, 
• Public goods, and 
• Incomplete information 
We shall discuss each of the above in detail. 
  
© The Institute of Chartered Accountants of India
 1.25 
 
 
 7.25 
PUBLIC FINANCE 
2.3.1 Market Power 
Market power or monopoly power is the ability of a firm to profitably raise the market price 
of a good or service over its marginal cost. Firms that have market power are price makers 
and therefore, can charge a price that gives them positive economic profits. Excessive market 
power causes the single producer or a small number of producers to restrict output (i.e 
produce and sell less output than would be produced in a competitive market) and charge 
price higher than what would prevail under perfect competition. These profits are not achieved 
due to operating efficiency, but due to market power and dominance. Thus, market fails to 
produce the right quantity of goods and services at the right price.  
2.3.2 Externalities 
We begin by describing externalities and then proceed to discuss how they create market 
inefficiencies. As we are aware, anything that one individual does, may have, at the margin, 
some effect on others. For example, if individuals decide to switch from consumption of 
ordinary vegetables to consumption of organic vegetables, they would, other things equal, 
increase the price of organic vegetables and potentially reduce the welfare of existing 
consumers of organic vegetables. However, we should note that all these operate through 
price mechanism i.e. through changes in prices. The price system works efficiently because 
market prices convey information to both producers and consumers. However, when a 
consumption or production activity has an indirect effect (either positive or negative) on 
consumption or production activities of others and such effects are not reflected directly in 
market prices, we call it an externality.  
Externalities are costs (negative externalities) or benefits (positive externalities), which are not 
reflected in free market prices. They are called externalities because they are “external” to the 
market. Externalities are also referred to as 'spillover effects', 'neighbourhood effects' 'third-
party effects' or 'side-effects', as the originator of the externality imposes costs or benefits on 
others who are not responsible for initiating the effect. Since it occurs outside the price 
mechanism, it has not been compensated for, or in other words it is uninternalized or the cost 
(benefit) of it is not borne (paid) by the parties. 
Externalities can be positive or negative. Negative externalities occur when the action of one 
party imposes costs on another party. Positive externalities occur when the action of one party 
confers benefits on another party.  
Production Externalities 
A negative production externality initiated in production which imposes an external cost on 
others may be received by another in consumption or in production. As an example,  
© The Institute of Chartered Accountants of India
1.  
  
BUSINESS ECONOMICS 
 
 7.26 
• A negative production externality is received in consumption when a factory which 
produces aluminium discharges untreated waste water into a nearby river and pollutes 
the water causing health hazards for people who use the water for drinking and 
bathing. 
• A negative production externality is received in production when pollution of river 
affects fish output as there will be less catch for fishermen due to loss of fish resources.  
The firm, however, has no incentive to account for the external costs that it imposes on 
consumers of river water or on fishermen when making its production decision. Additionally, 
these external costs are never reflected in the price of the product. 
A positive production externality initiated in production that confers external benefits on 
others may be received in production or in consumption. 
• A firm which offers training to its employees for increasing their skills generates 
positive benefits on other firms when they hire such workers as they change their jobs.  
• A positive production externality is received in consumption when an individual raises 
an attractive garden and the persons walking by enjoy the garden. These external 
effects were not in fact taken into account when the production decisions were made. 
Consumption Externalities 
Negative consumption externalities initiated in consumption which produce external costs on 
others may be received in consumption or in production.  
• smoking cigarettes in public place causing passive smoking by others, creating litter 
and diminishing the aesthetic value of the room and playing the radio loudly 
obstructing one from enjoying a concert are examples of negative consumption 
externalities affecting consumption 
• The act of undisciplined students talking and creating disturbance in a class preventing 
teachers from making effective instruction and the case of excessive consumption of 
alcohol causing impairment in efficiency for work and production are instances of 
negative consumption externalities affecting production. 
A positive consumption externality initiated in consumption that confers external benefits on 
others may be received in consumption or in production.  
• if people get immunized against contagious diseases, they would confer a social 
benefit to others as well by preventing others from getting infected.  
• Consumption of the services of a health club by the employees of a firm would result 
in an external benefit to the firm in the form of increased efficiency and productivity.  
 
© The Institute of Chartered Accountants of India
 1.27 
 
 
 7.27 
PUBLIC FINANCE 
When there are externalities and the costs or benefits are experienced by people outside a 
transaction, the actors in the transaction (consumers or producers) tend to ignore those 
external costs or benefits. 
Having discussed the nature of externalities in production and consumption, we shall now 
examine how externalities cause inefficiency and market failure. Before we attempt this, we 
need to understand the difference between private costs and social costs. Private cost is the 
money cost of production incurred by the firm i.e. costs such as wages, raw materials, heating 
and lighting which must be paid to carry out production, and these which would appear in 
the firm's accounts. The supply curve here corresponds to only the private marginal costs. 
Social costs refer to the total costs to the society on account of a production or consumption 
activity. Social costs are private costs borne by individuals directly involved in a transaction 
together with the external costs borne by third parties not directly involved in the transaction. 
In other words, social costs are the total costs incurred by the society when a good is 
consumed or produced.   It is thus private costs plus costs to third parties (i.e. private costs + 
total negative externalities). 
  Social Cost = Private Cost + External Cost 
The external costs are not included in firms’ income statements or consumers’ decisions. 
However, these external costs are real and important as far as the society is concerned. As we 
have mentioned above, firms do not have to pay for the damage resulting from the pollution 
which they generate. As a result, each firm’s cost which is considered for determining output 
would be only private cost or direct cost of production which does not incorporate 
externalities. 
The market prices determined without incorporating externalities are not ideal as they do not 
reflect all social costs and benefits. Such prices send incorrect signals to producers and 
consumers and cause either overproduction or underproduction.  Thus, we conclude that 
when there is externality, a competitive market will produce a level of output which is not 
socially optimal. This is a clear case of market failure.  
2.4 PUBLIC GOODS 
Paul A. Samuelson who introduced the concept of ‘collective consumption good’ in his path -
breaking 1954 paper ‘The Pure Theory of Public Expenditure’ is usually recognized as the first 
economist to develop the theory of public goods. A public good (also referred to as collective 
consumption good or social good) is defined as one which all enjoy in common in the sense 
that each individual’s consumption of such a good leads to no subtract ion from any other 
individuals’ consumption of that good. 
© The Institute of Chartered Accountants of India