Market failure and public goods

Public Goods

Author: Geoff Riley  Last updated: Sunday 23 September, 2012

When the market fails to provide certain goods and services, there is a clear case for government intervention.

The nature of public goods

Public goods are services which must be provided collectively for two main reasons:

• Non-excludability - the goods cannot be confined to those who have paid for it
• Non-rivalry in consumption - the consumption of one individual does not reduce the availability of goods to others

Examples of pure public goods include flood control systems, street lighting and national defence. A flood control system, such as the Thames Barrier, cannot be confined to those who have paid for the service. Also, the consumption of the service by one household will not reduce its availability to others. If left to the free market mechanism, no public goods would be provided and, as a result, there would be a clear market failure. No individual consumer would pay for a product that could be consumed for free if another household decided to purchase it. 

The benefits of the Thames Barrier cannot be confined only to those people who have paid for it

Quasi-public goods: These are products that are essentially public in nature, but do not exhibit fully the features of non-excludability and non-rivalry. The road network in the UK is currently available to all, but could be made excludable via a system of electronic road pricing. There is also non-rivalry in consumption, but only up to an extent. Once the road becomes congested there is rivalry in consumption.

Environmental public goods: An example of an environmental public good is public open space, which nobody would provide on their own, even though everybody benefits from it being available. Street lighting is another example of a public good.

The Air-Waves – a Quasi Public Good
The airwaves are essentially owned by the government of a particular country. Do they count as a pure public good? Normally the answer would be yes. One person’s use of the airwaves rarely reduces the extent to which other people can benefit from utilising them. But when demand for mobile phone services is high at peak times, the airwaves become crowded and access to the networks provided by the main mobile phone companies can become slow. In this sense the airwaves can be treated a crowded non-pure public good.
The government controls the issue of licences needed to operate mobile phone services using the airwaves in the UK. In 2000, they auctioned off five licences for 3rd generation mobile phone services and raised £22 billion in doing so. The government was using the auction process to ration the airwaves through a licence system. Although the government has monopoly control in the sense that it controls the issue of licences, it did not set the market price. This was determined by the auction process, and the fact that at the end of a bidding war, the major mobile phone companies were prepared to pay such a high price for a licence to allow them to operate in the market, is evidence of the private benefit (or anticipated future profit) that the companies expected to make from selling 3rd generation contracts to customers.
The fact that these telecoms companies may have greatly misjudged the actual market demand for third generation mobile phone services is not the result of the auction process itself. The government decided that the income from the sale of these licences would be used to repay a slice of the national debt, providing a bonus for current and future generations in terms of reducing the annual interest payments on government debt.

An example of a quasi public good - the air-waves can become congested

Finding an Equilibrium Allocation of Public Goods that Maximises Social Welfare

Finding the socially efficient level provision of public goods is a hugely difficult process. First we must seek a valuation of the willingness and ability of consumers to pay for public goods which involves estimating the individual demand curves for each consumer and then aggregating to find the “market demand curve” – a reflection of the social marginal benefit (or valuation) that consumers place on each extra unit of a public good that is made available.
In the diagram below we consider a non-pure public good whose marginal cost of supply does rise gently as output is increased. If the market fails to provide a sufficient quantity of a public good, then there is a loss of economic (social) welfare.

Case Study: The BBC as a public good

Broadcasting is a good example of a public good. Let us remind ourselves of the three main characteristics of a public good.

Firstly it is non-rival, meaning that the consumption of a public good or service by one individual does not preclude consumption by another individual. Secondly, consumption is non-excludable. This means that consumption by one individual makes it impossible to exclude any other individual from having the opportunity to consume. Effectively the marginal cost of providing a pure public good to an extra user is zero, and this implies that, in order to achieve allocative efficiency, the charge for the product should be zero. Of course, in this situation, private sector businesses are unlikely to consider providing pure public goods because they will not be able to make any profit at a zero price, and many consumers can take a free ride on such goods because of non-excludability. The provision of pure public goods is therefore a cause of market failure. Left to the free market, public goods are under-provided and under-consumed leading to a loss of social welfare.

Traditional analogue broadcasting differs from encrypted digital broadcasting in the sense that digital broadcasters can now exclude non-payers using set-top boxes. But even when Britain moves fully to digital when the analogue signal is turned off in a few years, the broadcasting services will continue to be completely non-rival and it is this that really matters in the context of the services that the BBC provides. One extra person consuming programmes on BBC1 or BBC2 has no effect at all on the ability of people to consume other services provided by the BBC.

Paying for a public good - the licence fee debate

At the moment, around 23 million households in Britain pay an annual licence fee. All of these people are stakeholders in the debate about the future funding of the BBC and the vast majority use one or more BBC services at least once a week. The fee is a means of providing collective payment for a public good. We know that there are fee-dodgers who try to take a free-ride by avoiding payment, but there are well established although costly means to enforce the licence fee and take non-payers to court.

According to research undertaken by the BBC as part of the Charter Review, on rough estimates, about 17 million households value BBC television, radio and internet services at more than the current licence fee of £122. These are gainers from the existence of the BBC. In contrast, the study finds that 6 million people value the BBC at less than the current licence fee. These are losers – they are paying more than the utility that they get and many such people may resent having to pay the licence fee when they have paid for theirBSkyB subscription and have already deserted the BBC for other digital or commercial channels. The BBC study estimates that the net consumer surplus created by the BBC is well over £2bn/year, or ¼% of GDP.

The most likely groups to think the licence fee represents good value for money for their household are those aged over 60 and those in the higher AB social groups. Groups more likely to think the fee represents poor value for money are those with multi-channel television access, people aged 31-45, people in the C2DEs social groups and younger people of Black or Asian origin. People in C2DE social groups are far more likely to have an income below the median, and therefore the question of raising the licence fee becomes important because a sharp rise in its level would affect people’s ability to pay.

Television	Radio	Other
BBC 1	Radio 1	BBC Online
BBC 2	Radio 2	World Service
BBC 3	Radio 3	BBC Scotland
BBC 4	Radio 4	BBC Northern Ireland
Cbeebies	Radio Five Live	BBC Wales
CBBC	Five Live Extra	BBC English Regions
BBC News 24	1Xtra
BBC Parliament	6 Music
	BBC 7
	Asian Network
	6 Nations services
	40 local and regional services

For millions of people, the value that they derive from the BBC’s output does exceed the price they currently have to pay via the licence fee. Would they be happy to pay a significantly higher fee in the future? Much would depend on the quality and range of broadcasting that the BBC is able to deliver. Assuming a constant range, reliability and quality of services, a large rise in the BBC licence fee would reduce total consumer surplus. The BBC study estimates that if the fee was raised by forty per cent from £122 to £170, up to four million people would no longer value BBC services as much as the higher compulsory fee, consumer surplus would be reduced and the BBC’s services might end up being under-consumed.

This, in a nutshell, is the argument against the introduction of a subscription-based system for funding the BBC. It would exclude several million people from consuming their services and would probably result in a net loss of social welfare.

What is the best way to finance broadcasting? Should the licence fee remain compulsory?

Criticisms of the licence fee

Opponents of the licence fee argue that

1. It is a regressive form of taxation – everyone pays the same flat charge, regardless of their disposable income, the number of televisions they own or the extent to which they watch television in general and BBC services in particular
2. As fewer people watch the BBC, the case for a licence fee diminishes. Indeed as technology develops, it become even harder to sustain a compulsory licence fee when people have moved predominantly to alternative sources of information through the internet, digital channels, broadband and their mobile phones
3. The costs of collection and evasion are high including £150 million per year chasing licence-fee evaders

What are the alternatives for funding the BBC?

• Moving to a subscription base system (technology may allow this in the future).
• Allowing advertising and sponsorship of programmes similar to the ITV model.
• Greater emphasis on selling BBC programmes overseas through BBC Worldwide and sales of DVDs to generate increased revenue for the BBC.
• Funding the BBC entirely through direct taxation and scrapping the licence fee.
• A tax on the revenues of other commercial broadcasters to part-fund the BBC’s services – reflecting the public service nature of much of the BBC’s output.

Of these alternatives, introducing advertising is least preferred among people surveyed. A sizeable majority of viewers (over sixty per cent according to a recent MORI poll) regard advertising as an intrusion to their enjoyment of programmes, and few think that the BBC should move to this form of finance. And there are worries that the total size of the TV advertising market is not large enough to absorb the entry of the BBC as a supplier of advertising slots. It might well damage the financial viability of ITV for example. In any case, advancing technology now allows viewers to skip advertising when they have pre-recorded programmes.

On the whole, there is a preference for keeping the licence fee (a system of funding used in many other countries) although there are concerns among older groups about their ability to pay for it. But without a sizeable increase in its value, there is little doubt that BBC revenues will soon be overtaken permanently by Sky and this will damage the BBC’s ability to bid for live television events including the rights for sports such as soccer, cricket and golf.

Public Goods and the Free Rider Problem

Consumers have an incentive to not reveal their willingness and ability to pay for public goods if they believe that they will be expected or required to contribute to financing the public good accordingly by the government. After all, if the public good is supplied, it will be available to them just as it would be to anyone else because pure public goods are non-excludable.  This is the essence of the “free rider problem”: the incentive which consumers have to avoid contributing to financing public goods in proportion to their valuation of such good.

Good examples to use include TV licence dodgers and people who choose to evade the Council Tax but who still receive local authority services. Another example might be a group of residents in a block of flats who all stand to benefit from the refurbishment of an adjacent playground or better lighting and security systems, but who individually might try to avoid payment and benefit once the improved amenities are in place.

Given the nature of the free rider problem, public goods are often financed through some form of enforcement, notably the compulsory nature of the TV licence fee, management fees for residents living in blocks of accommodation or the signing of international treaties on the environment.  .

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What is Government Failure?

Introduction

A failure of the free market and the price mechanism to deliver an allocatively efficient allocation of scarce resources is normally regarded as justification for government intervention.

This intervention is designed to correct for instances of market failure and achieve an improvement in economic and social welfare.

But what if intervention leads to further inefficiencies? What if government policies prove to be costly to implement but ineffective in achieving their desired outcomes? What happens if intervention distorts markets still further leading to a further loss of efficiency?

What is Government Failure?

Even with good intentions governments seldom get their policy application correct. They can tax, control and regulate but the outcome may be a deepening of the market failure or even worse a new failure may arise

Government failure may range from the trivial, when intervention is merely ineffective, but where harm is restricted to the cost of resources used up and wasted by the intervention, to cases where intervention produces new and more serious problems that did not exist before. The consequences of this can take many years to reverse.

Government failure in a non-market economy

The collapse of the Soviet Union in the late 1980s marked the failure of command economies as a means of allocating resources among competing uses. The essence of a command economy was that the state planning mechanism would decide what to produce and how to produce it and for whom to produce. Government failure occurred when the central planners produced products that were not wanted by consumers – a loss of allocative efficiency, since there was no price mechanism to signal changes in consumer preferences and demand.

Another fundamental failing of the pure command economy was that there was little incentive for workers to raise productivity; poor quality control; and little innovation by firms as no profit motive existed. Command economies also suffered massive environmental de-gradation because they did not posses structures for valuing the environment and giving consumers and producers the right incentives to protect their environmental heritage.

Example of Government Failure – Fisheries Policy in the European Union
Few policies have attracted as much criticism and contempt as the Common Fisheries Policy of the European Union. To many it is a prime example of government failure; a policy with good intentions that has failed to achieve its objectives and caused much deeper problems for the European fishing industry.
At the heart of the problem is overfishing – the ‘tragedy of the commons’ - 30% of EU fish stocks are beyond safe limits.
The EU quota system does not work well in restoring fish stocks and the EU fishing sector suffers from overfishing, fleet overcapacity, heavy subsidies and decline in the volume of fish caught. Many European governments seek to protect the interests of their own fishing businesses rather than agree on a policy that will benefit the EU sea fishing industry as a whole.
Over-fishing is a cause of market failure arising from a failure to enforce agreed fishing quotas and the absence of enforceable property rights for what is perceived to be a common ownership of a natural and renewable resource.
One key demand for reform is to end dumping of discarded fish. Currently, up to half the catch of some species has to be discarded because vessels have exceeded their quota, or because the fish are undersized.

Causes of Government Failure

Government intervention can prove to be ineffective, inequitable and misplaced.

(a) Political self-interest

The pursuit of self-interest amongst politicians and civil servants can often lead to a misallocation of resources.

For example decisions about where to build new roads, by-passes, schools and hospitals may be decided with at least one eye to the political consequences. 

The pressures of a looming election or the influence exerted by special interest groups can foster an environment in which inappropriate spending and tax decisions are made. - e.g. boosting welfare spending in the run up to an election, or bringing forward major items of capital spending on infrastructural projects without the projects being subjected to a full and proper cost-benefit analysisto determine the likely social costs and benefits. Critics of current government policy towards tobacco taxation and advertising, and the controversial issue of genetically modified foods argue that government departments are too sensitive to political lobbying from the major corporations.

(b) Policy myopia

Critics of government intervention in the economy argue that politicians have a tendency to look for short term solutions or “quick fixes” to difficult economic problems rather than making considered analysis of long term considerations. 

For example, a decision to build more roads and by-passes might simply add to the problems of traffic congestion in the long run encouraging an increase in the total number of cars on the roads.

The risk is that myopic decision-making will only provide short term relief to particular problems but does little to address structural economic problems.

Critics of government subsidies to particular industries also claim that they distort the proper functioning of markets and lead to inefficiencies in the economy. For example short term financial support to coal producers to keep open loss-making coal pits might prove to be a waste of scarce resources if the industry concerned has little realistic prospect of achieving a viable rate of return in the long run given the strength of global competition. 

(c) Regulatory capture

This is when the industries under the control of a regulatory body (i.e. a government agency) appear to operate in favour of the vested interest of producers rather can consumers

Some economists argue that regulators can prevent the ability of the market to operate freely. We might find examples of this in agriculture, telecommunications, the main household utilities and in transport regulation.

For example, to what extent has the system of agricultural support known as the Common Agricultural Policy operated too much in the interests of farmers and the farming industry in general? And as a result, has the CAP worked against the long-term interest of consumers, the environment and developing countries who claim that they are being unfairly treated in world markets by the effects of import tariffs on food and export subsidies to loss-making European farmers?

(d) Government intervention and disincentive effects

Free market economists who fear government failure at every turn argue that attempts to reduce income and wealth inequalities can worsen incentives and productivity. They would argue against the National Minimum Wage because they believe that it artificially raises wages above their true free-market level and can lead to real-wage unemployment. They would argue against raising the higher rates of income taxbecause it is deemed to have a negative effect on the incentives of wealth-creators in the economy and generally acts as a disincentive to work longer hours or take a better paid job.

(e) Government intervention and evasion

A decision by the government to raise taxes on de-merit goods such as cigarettes might lead to an increase in attempted tax avoidance, tax evasion, smuggling and the development of grey markets where trade takes place between consumers and suppliers without paying tax

Case Study: The Unintended Economic Effects of a Tariff

In 2005 the US government slapped anti-dumping tariffs on the imports of Chinese furniture. At the time, imports accounted for 58% of the market for beds and similar items.

What happened next was probably not in the plans of US lawmakers and the local furniture manufacturers who supported the tariffs. Although imports from China did fall sharply, a number of Chinese manufacturers moved their plants to different countries, Vietnam being the main choice. The result was that as of 2010, imports now account for 70% of the total market!

A decision to legalize and then tax some drugs might lead to a rapid expansion of the supply of drugs and a substantial loss of social welfare arising from over consumption.

(f) Policy decisions based on imperfect information

• How does the government establish what citizens want it to do in their name?  Can the government ever really know the true revealed preferences of so many people?
• Often a government will choose to go ahead with a project or policy without having the full amount of information required for a proper cost-benefit analysis. The result can be misguided policies and damaging long-term consequences.
• How does the government know how many extra houses need to be built in the UK over the next twenty years? Is building thousands of extra homes in an already congested South-east the right option? Are there better solutions? There have been plenty of instances of government housing policy having failed in previous decades!

(g) The Law of Unintended Consequences

• The law of unintended consequences is that actions of consumer and producers — and especially of government—always have effects that are unanticipated or "unintended."Particularly when people do not always act in the way that the economics textbooks would predict
• The law of unintended consequences is often used to criticise the effects of government legislation, taxation and regulation. People find ways to circumvent laws; shadow markets develop to undermine an official policy; people act in unexpected ways because or ignorance and / or error. Unintended consequences can add hugely to the financial costs of some government programmes so that they make them extremely expensive when set against their original goals and objectives.

(h) Costs of administration and enforcement

Government intervention can prove costly to administer and enforce. The estimated social benefits of a particular policy might be largely swamped by the administrative costs of introducing it.

Key points about government failure

• Free market economists are distrustful of intervention. They believe that the price mechanismshould be given freedom to operate
• Often we can accuse the government of policy failure only with the benefit of hindsight
• Limited information - no government has the resources and information available to it to make fully-informed, objective judgements. That is the nature of politics.
• Government failure is most likely to occur when decisions are made in the vested interest of special interest groups, at the expense of other groups (the result is a loss of equity)

Using the cost-benefit principle in AS micro economics

The cost-benefit principle is one of those core ideas that can be brought into so many discussions both in micro and macroeconomics – you should be using it in your papers tomorrow.

The cost-benefit principle says that you should take an action if, and only if, the extra benefit from taking it is greater than the extra cost

Here are some examples where the principle might be built into your analysis and evaluation

• Costs and benefits of subsidies e.g. the bio-fuel debate or subsidies for industries affected by globalisation
• Costs and benefits of indirect taxes e.g. environmental taxes or taxes designed to curb demand for / consumption of de-merit goods
• Costs and benefits of the introduction of competition into a market e.g. postal market liberalisation
• Costs and benefits of an increase in government spending on public goods and merit goods such as flood defence schemes, free entry to museums and galleries
• Costs and benefits of different strategies designed to reduce income and wealth inequality e.g. the national minimum wage or a rise in the top rate of income tax
• Costs and benefits of the introduction of carbon trading as a way of reducing CO2 emissions
• Costs and benefits of different policies designed to reduce unemployment e.g. comparing the effectiveness of investment in training with an employment subsidy for the long term unemployed
• Costs and benefits of major infrastructural projects such as new motorways, London 2012
• Costs and benefits of a decision to relax planning controls on new house-building

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Basic Economic Problem-Scarcity and choice

The Economist's Dictionary of Economics defines economics as

"The study of the production, distribution and consumption of wealth in human society"

The purpose of economic activity

It is often said that the central purpose of economic activity is the production of goods and services to satisfy our ever-changing needs and wants.

The basic economic problem is about scarcity and choice. Every society has to decide:

• What goods and services to produce? Does the economy uses its resources to build more hospitals, roads, schools or luxury hotels? Do we make more iPhones and iPads or double-espressos? Does the National Health Service provide free IVF treatment for childless couples?
• How best to produce goods and services? What is the best use of our scarce resources? Should school playing fields be sold off to provide more land for affordable housing? Should we subsidise the purchase of solar panels for roofs?
• Who is to receive goods and services? Who will get expensive hospital treatment - and who not? Should there be a minimum wage? Or perhaps a living wage? What are the causes and consequences of poverty in societies across the globe?

Scarcity

We are always uncovering of new wants and needs which producers attempt to supply by using factors of production. For a perspective on the achievements of countries in meeting people’s basic needs, theHuman Development Index produced by the United Nations is worth reading. The economist Amartya Sen(Winner of the 1998 Nobel Prize for Economics) has written extensively on this issue.

Scarcity means we all have to make choices

Because of scarcity, choices must be made by consumers, businesses and governments. For example, over six million people travel into London each day and they make decisions about when to travel, whether to use the bus, the tube, to walk or cycle or work from home. Millions of decisions are taken, many of them are habitual – but somehow on most days, people get to work on time and they get home too in safety if not in comfort!

Key Point: Trade-offs and Choices

Making a choice made normally involves a trade-off – this means that choosing more of one thing can only be achieved by giving up something else in exchange. 

“Every purchase is a trade-off, of course. If you decide to spend $20,000 on a new car, you’re saying that’s worth more to you than 20 bicycles or four vacations to Europe or the down payment on a house. Every choice involves opportunity costs; when you choose one thing, you’re giving up others. Plus, what you’re giving up isn’t always financial.Or obvious.”

1. Housing: Choices about whether to rent or buy a home – both decisions involve risk. People have to weigh up the costs and benefits of the decision.
2. Working: Do you work full-time or part-time? Is it worth your while studying for a degree? How have these choices been affected by the introduction of university tuition fees?
3. Transport and travel: The choice between using Euro-Tunnel, a low-cost ferry or an airline when travelling to Western Europe.

Key Point: The Cost Benefit Principle

• In many decisions where people consider the costs and benefits of their actions – economists make use of the ‘marginal’ idea, for example what are the benefits of consuming a little extra of a product and what are the costs?
• Rational decision-makers weigh the marginal benefit one receives from an option with its marginal cost, including the opportunity cost.
• This cost benefit principle well applied will get you a long way in economics!
• But keep in mind that behavioural economics questions the rationality of many of our decisions!

What is production possibility frontier? (PPF) IGCSE notes.

A production possibility frontier (PPF) is a curve or a boundary which shows the combinations of two or more goods and services that can be produced whilst using all of the available factor resources efficiently.

We normally draw a PPF on a diagram as concave to the origin. This is because the extra output resulting from allocating more resources to one particular good may fall. I.e. as we move down the PPF, as more resources are allocated towards Good Y, the extra output gets smaller – and more of Good X has to be given up in order to produce the extra output of Good Y. This is known as the principle of diminishing returns. Diminishing returns occurs because not all factor inputs are equally suited to producing different goods and services.

Combinations of output of goods X and Y lying inside the PPF occur when there are unemployed resources or when the economy uses resources inefficiently. In the diagram above, point X is an example of this. We could increase total output by moving towards the production possibility frontier and reaching any of points C, A or B.

Point D is unattainable at the moment because it lies beyond the PPF. A country would require an increase in factor resources, or an increase in the efficiency (or productivity) of factor resources or animprovement in technology to reach this combination of Good X and Good Y. If we achieve this then output combination D may become attainable.

Producing more of both goods would represent an improvement in our economic welfare providing that the products are giving consumers a positive satisfaction and therefore an improvement in what is calledallocative efficiency

Reallocating scarce resources from one product to another involves an opportunity cost. If we go back to the previous PPF diagram, if we increase our output of Good X (i.e. a movement along the PPF from point A to point B) then fewer resources are available to produce good Y. Because of the shape of the PPF the opportunity cost of switching resources increases – i.e. we have to give up more of Good Y to achieve gains in the output of good X.

The PPF does not always have to be drawn as a curve. If the opportunity cost for producing two products is constant, then we draw the PPF as a straight line. The gradient of that line is a way of measuring the opportunity cost between two goods.

Explaining Shifts in the Production Possibility Frontier

The production possibility frontier will shift when:

• There are improvements in productivity and efficiency perhaps because of the introduction ofnew technology or advances in the techniques of production)
• More factor resources are exploited perhaps due to an increase in the size of the workforce or a rise in the amount of capital equipment available for businesses

In the diagram below, there is an improvement in technology which shifts the PPF outwards. As a result of this, output possibilities have increased and we can conclude (providing the good provides positive satisfaction to consumers) that there is an improvement in economic welfare.

Technology, prices and consumer welfare

Improved technology should bring market prices down and make products more affordable to the consumer. This has been the case in the market for personal computers and digital products. The exploitation of economies of scale and improvements in production technology has brought prices down for consumers and businesses.

External Costs

In the case of air pollution there is an external cost to society arising from the contamination of our air supplies. External costs are those costs faced by a third party for which no compensation is forthcoming. Identifying and then estimating a monetary value for air pollution can be a very difficult exercise – but one that is important for economists concerned with the impact of economic activity on our environment. We will consider this issue in more detail when we study externalities and market failure.

Free Goods

Not all goods have an opportunity cost. Free goods are not scarce and no cost is involved when consuming them.

Air conditioning uses up scarce resources especially during hot weather

Is fresh air an example of a free good? Usually the answer is yes – yet we know that air can become contaminated by pollutants. And, in thousands of offices, shops and schools, air-conditioning systems cool the air before it is “consumed”. With air conditioning, scarce resources are used up in providing the “product” – for example the capital machinery and technology that goes into manufacturing the air conditioning equipment; the labour involved in its design, production, distribution and maintenance and the energy used up in powering the system.

Cool air might appear to be free – but in fact it is often an expensive product to supply!

What is Public Limited company?

Public Limited company

Limited companies which can sell share on the stock exchange are Public Limited companies. These companies usually write PLC after their names. Minimum value of shares to be issued (in UK) is £50,000.

Advantages

• There is limited liability for the shareholders.
• The business has separate legal entity. There is continuity even if any of the shareholders die.
• These businesses can raise large capital sum as there is no limit to the number of shareholders.
• The shares of the business are freely transferable providing more liquidity to its shareholders .

Disadvantages

• There are lot of legal formalities required for forming a public limited company. It is costly and time consuming.
• In order to protect the interest of the ordinary investor there are strict controls and regulations to comply. These companies have to publish their accounts.
• The original owners may lose control.
• Public Limited companies are huge in size and may face management problems such as slow decision making and industrial relations problems.

What is franchising?

The term "franchising" can describe some very different business arrangements. It is important to understand exactly what you're being offered.

Franchise occurs when the owner of a business (the franchisor) grants a licence to another person or business (the franchisee) to use their business idea - often in a specific geographical area.

The franchisee sells the franchisor's product or services, trades under the franchisor's trade mark or trade name and benefits from the franchisor's help and support.

In return, the franchisee usually pays an initial fee to the franchisor and then a percentage of the sales revenue.

The franchisee owns the outlet they run. But the franchisor keeps control over how products are marketed and sold and how their business idea is used.

Well-known businesses that offer franchises of this kind include Prontaprint, Dyno-Rod, McDonald's and Coffee Republic.

Advantages and disadvantages of franchising

Buying a franchise can be a quick way to set up your own business without starting from scratch. But there are also a number of drawbacks.

Advantages

• Your business is based on a proven idea. You can check how successful other franchises are before committing yourself.
• You can use a recognised brand name and trade marks. You benefit from any advertising or promotion by the owner of the franchise - the "franchisor".
• The franchisor gives you support - usually including training, help setting up the business, a manual telling you how to run the business and ongoing advice.
• You usually have exclusive rights in your territory. The franchisor won't sell any other franchises in the same region.
• Financing the business may be easier. Banks are sometimes more likely to lend money to buy a franchise with a good reputation.
• Risk is reduced and is shared by the franchisor.
• If you have an existing customer base you will not have to invest time looking to set one up.
• Relationships with suppliers have already been established.

Disadvantages

• Costs may be higher than you expect. As well as the initial costs of buying the franchise, you pay continuing royalties and you may have to agree to buy products from the franchisor.
• The franchise agreement usually includes restrictions on how you run the business. You might not be able to make changes to suit your local market.
• The franchisor might go out of business, or change the way they do things.
• Other franchisees could give the brand a bad reputation.
• You may find it difficult to sell your franchise - you can only sell it to someone approved by the franchisor.
• Reduced risk means you might not generate large profits.

What is a Co-operative?

A cooperative is defined as an autonomous association of persons united voluntarily to meet their common economic, social, and cultural needs and aspirations through a jointly-owned and democratically-controlled enterprise.

A cooperative may also be defined as a business owned and controlled equally by the people who use its services or who work at it.

There are different types of co-operatives:

Housing cooperative

A housing cooperative is a legal mechanism for ownership of housing where residents either own shares reflecting their equity in the co-operative's real estate, or have membership and occupancy rights in a not-for-profit co-operative and they underwrite their housing through paying subscriptions or rent.

Building cooperative

Members of a building cooperative (in Britain known as a self-build housing co-operative) pool resources to build housing, normally using a high proportion of their own labour. When the building is finished, each member is the sole owner of a homestead, and the cooperative may be dissolved.

Retailers' cooperative

A retailers' cooperative (known as a secondary or marketing co-operative in some countries) is an organization which employs economies of scale on behalf of its members to get discounts from manufacturers and to pool marketing. It is common for locally-owned grocery stores, hardware stores and pharmacies. In this case the members of the cooperative are businesses rather than individuals.

Utility cooperative

A utility cooperative is a public utility that is owned by its customers. It is a type of consumers' cooperative. In the US, many such cooperatives were formed to provide rural electrical and telephone service.

Worker cooperative

A worker cooperative or producer cooperative is a cooperative that is owned and democratically controlled by its "worker-owners". There are no outside owners in a "pure" workers' cooperative, only the workers own shares of the business, though hybrid forms in which consumers, community members or capitalist investors also own some shares are not uncommon. Membership is not compulsory for employees, but generally only employees can become members. However, in India there is a form of workers' cooperative which insists on compulsory membership for all employees and compulsory employment for all members. That is the form of the Indian Coffee Houses. This system was advocated by the Indian communist leader A. K. Gopalan.

Consumers' cooperative

A consumers' cooperative is a business owned by its customers. Employees can also generally become members. Members vote on major decisions, and elect the board of directors from amongst their own number. A well known example in the United States is the REI (Recreational Equipment Incorporated) co-op, and in Canada: Mountain Equipment Co-op.
The world's largest consumers' cooperative is the Co-operative Group in the United Kingdom, which offers a variety of retail and financial services. The UK also has a number of autonomous consumers' cooperative societies, such as the East of England Co-operative Society and Midcounties Co-operative.
Migros is the largest supermarket chain in Switzerland and keeps the cooperative society as its form of organization.
Coop is another Swiss cooperative which operates the second largest supermarket chain in Switzerland after Migros.

Agricultural cooperative

Agricultural cooperatives are widespread in rural areas.
In the United States, there are both marketing and supply cooperatives. Agricultural marketing cooperatives, some of which are government-sponsored, promote and may actually distribute specific comodities. There are also agricultural supply cooperatives, which provide inputs into the agricultural process.
In Europe, there are strong agricultural / agribusiness cooperatives, and agricultural cooperative banks. Most emerging countries are developing agricultural cooperatives.