IIM A - Day to day economics Ch.1 - Interrelationship between Public and Private sectors

To understand why some goods and services are offered by privatized firms and some are provided by the Govt. itself we have to understand the concept of market failures and the causation of the same due to the presence of:
1. Natural monopoly
2. The presence of exclusivity and rivalry- the concept of public goods
3. The presence of externality

• Natural Monopoly: If, for example, a private enterprise tries to provide the nationwide railway service for a country then initially it'll encounter with an extremely high capital cost for setting up the whole system: starting from the manufacturing of the trains, the rails, the signalling system, platforms and what not, then the huge amount of maintenance cost will be there, this itself is an impossible task for a single private firm to carry out; and with the presence of many private firms, the market will get divided and afterwards, to recover these extremely high costs, these private firms will increase the per unit price of such services provided. Due to the collective contribution of two factors. i.e. high costs incurred to provide the service and segmented market due to the presence of multiple firms this market system becomes impossible. Thus, this whole venture can be profitable if and only if there is only one firm present in the market, so that it can recover its costs and generate profit by utilizing the volume of sales generated from services provided to the whole of the country. Thus, this becomes a natural monopoly, i.e. the presence of more than one firm results in an increase of the per unit price of the goods and services provided and only a single firm can function profitably in such a set up. But, a private firm in all possible cases can not operate in such a market as it'll seek to increase its profit margins due to its profit maximizing mindset and also, with the absence of any competition it'll dictate the price of goods and service as it wishes, thus it will operate as a 'monopolist'. This result in market failure and to curb this the Govt. should intervene and provide such goods and services to its countrymen at a price near to the competitive price. That's why we see in most of the countries the Govt. is in charge of services like the railways, providing drinking water etc.
  
• Public goods: Goods which have the two characteristics of non-rivalry and non-exclusivity are called public goods. To explain further, if I buy a car then that same car can't be bought by any other buyer, thus there's a rivalry seen in case of purchasing of such goods. Also, the availability of some goods and services becomes exclusive due to the relative buying power of that particular set of people. For an example, if I buy a ticket for a movie then that particular seat won't be available to anyone else and also the movie can only be watched by the people who had bought the ticket and no one else won't be able to watch it. But in case of the National Defense, Police services etc. these things are characterized by non-rivalry and non-exclusivity. i.e National Defense services are provided to all the citizens of the nation and the availability of the service to one person doesn't render it unavailable to the other, the availability of such goods and services doesn't depend of the relative buying power of people also, everyone can enjoy the benefits of these. These type of goods which are non-rivalrous and non-exclusive in nature are termed as Public goods and only the Govt. can provide such goods and services.
  
• Externality: If the production of a good or service affects a bystander who isn't directly involved in producing the same then the phenomenon of externality occurs. Market failures occurred due to externality are tackled by Govt. intervention. In case of positive externality the goods or services maybe subsidized. For example, the production of e-vehicle Reva was subsidized by the Indian Govt. as the car didn't cause any air pollution and thus affected the life and health of the society in a positive way. However, in case of negative externality, taxes are levied. For example, to curb the consumption of liquor and cigarettes, taxes are imposed on them; also, to curb pollution, the firms who produce pollutants beyond a certain limit have to pay penalties and taxes; incidentally, these are called 'sin tax' and 'green tax' respectively.

Thus, due to the present of the economic phenomenon of market failure, the Govt. intervention is required and there are some goods and services (like the railways service, supply of drinking water, National defense etc.), which only the Govt. can provide.