Supply, demand for the Public Sector

Economic efficiency-creating as much value as possible from a given set of resources-is a goal by which alternative institutions and policies can be judged. Two conditions must be met to achieve economic efficiency: (a) all activities that produce more benefits than costs for the individuals within an economy must be undertaken and (b) activities that generate more costs than benefits to the individuals must not be undertaken. If only the buyer and the seller are affected, production and exchange in competitive markets are consistent with the ideal efficiency criteria.

Lack of competition may make it possible for a group of sellers to gain by restricting output and raising prices. There is a conflict between (a) the self-interest of sellers that leads them to collude, restrict output, and raise product prices above their production costs and (b) economic efficiency. Public-sector action-promoting competition or regulating private firms-may be able to improve economic efficiency in industries in which competitive pressures are lacking.

The market will tend to underallocate resources to the production of goods with external benefits and overallocate resources to those products that generate external costs.

Public goods are troublesome for the market to handle because non paying customers cannot easily be excluded. Since the amount of a public good that each individual receives is largely unaffected by whether he or she helps pay for it, most individuals will contribute little. The market will thus tend to undersupply public goods.

The public sector can improve the operation of markets by providing a stable economic environment.

The public sector is an alternative means of organizing economic activity. Public-sector decision-making will reflect the choices of individuals acting as voters, politicians, financial contributors, lobbyists, and bureaucrats. Public choice analysis applies the principles and methodology of economics to group decision-making to-help us understand  collective organizations.

Successful political candidates will seek to offer programs that voters favor, voters, in turn, will be attracted to candidates who reflect the voters own views and interests. In a democratic setting there are two major reasons why voters will turn to collective organization - (a) to reduce waste and inefficiency stemming from noncompetitive markets,  externalities, public goods, and economic instability and (b) to alter the income distribution.

Public-sector action may sometimes improve the market's efficiency and lead to an increase in the community's welfare, all individuals considered. However, the political process is likely to conflict with ideal economic efficiency criteria when (a) voters have little knowledge of an issue (b) special interests are strong and/or (c) political figures can gain from following shortsighted policies.