In the approach to the analysis of public sector choices known as public interest theory, decision making is a technical matter. The task of government officials is to locate the efficient solution and find a way to move the economy to that point.
For a public good, the efficient solution occurs where the demand curve that reflects social benefits intersects the supply curve for producing the good; that is, the solution at quantity Qe and price P1given in Panel (a) of Figure 15.3 Because this demand curve for a public good is not revealed in the market, the task for government officials is to find a way to estimate these curves and then to arrange for the production of the optimum quantity. For this purpose, economists have developed an approach called cost-benefit analysis, which seeks to quantify the costs and benefits of an activity. Public officials can use cost-benefit analysis to try to locate the efficient solution. In general, the efficient solution occurs where the net benefit of the activity is maximized.
Public sector intervention to correct market failure presumes that market prices do not reflect the benefits and costs of a particular activity. If those prices are generated by a market that we can regard as perfectly competitive, then the failure of prices to convey information about costs or benefits suggests that there is a free-rider problem on the demand side or an external cost problem on the supply side. In either case, it is necessary to estimate costs or benefits that are not revealed in the marketplace.
The public interest perspective suggests an approach in which policy makers identify instances of potential market failure and then look for ways to correct them. Public choice theory instead looks at what motivates the people making those policy choices.
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