In school I learnt about Market Failures in Microeconomics. For a while I believed that in case of public goods there is market failure at which point government regulation is required to fix the problem. Many economists who would otherwise support markets also seem to believe this.

For the uninitiated, public goods are those where consumption is either non-exclusive or no-rival or both. Because it is difficult to exclude parties there is the free rider problem and because sometimes it may be non-rival consumption there may be no incentive to bear the costs to exclude the free riders. This leads to the classic Free Rider Problem which leads to market failure.

This part is fairly correct, but the presumption that market failure can only be fixed by government intervention is grossly misguided. Market failure is often solved by markets. And far more efficiently might I add.

I was in Prague last weekend, which is for another more detailed post, and saw the most wonderful example of markets fixing market failure.

A tour guide taking around groups at tourist spots faces the free rider problem all the time. It is difficult to exclude other tourists who are also at the monuments and the consumption may be rival as those who paid for the guide get crowded out. In Prague I saw that the tour guides have small microphones and each person in the group has headphones. A passerby can’t hear anything and cannot free ride on the tourists who paid the guide. It is also wonderful because they don’t cause any nuisance to other tourists who just want to look around peacefully.

How would the government deal with this problem? They would regulate the number of tourists each guide can have in a group. Furthermore they would regulate the distance each group must maintain and each individual must maintain from the groups. Then they would issue licenses to guides and have Tourist Inspectors for enforcing the regulations and ensuring the correct distance is maintained. So much more efficient isn’t it? Or so they said in school.

Update: I am particularly interested in market failure in the tour guide business because I could have an alternative career as a diminutive tourist guide!