124 
ity with the relative desires and abilities of the participants to pay. If 
certain basic conditions are met, there will exist a set of market prices 
such that profit-maximizing firms and benefit-maximizing consumers 
who respond to those prices will automatically direct the economic 
system into the most efficient (consistent with the values of society) 
allocative position. 
Even the most loyal defenders of the competitive market system 
must admit that there are cetam circumstances in which markets fail 
to provide certain worthwhile outputs and overproduce or under- 
produce others, in addition to producing outputs in no way considered 
beneficial. Such situations come about because the conditions and as- 
sumptions upon which conclusions about the efficiency of a market 
system are based are not satisfied in reality! It is important now to 
investigate when and why private markets might not work well in 
order to determine the correct steps that might be taken within the 
institutional environment to correct misallocations of certain scarce 
resources. 
What then are the conditions necessary for markets to function 
smoothly? 3°? The ones most germane to this analysis are as follows: 
(1) the availability of information; (2) the presence of identifiable 
transaction costs; and (3) the characteristics of goods and services 
must meet certain criteria. 
(1) Information is an important factor in any efficient operation. 
Producers need knowledge of available technologies, demand, and 
potential markets, and the costs of factor inputs. Consumers need 
to know what goods are available and what their characteristics are. 
Both need to know the relevant set of prices. In some instances, 
information may be scarce, costly, unreliable, or hard to understand, 
interpret, and evaluate without special training. 
(2) Identifiable transaction costs mirror the ability of the market 
to translate (and measure) potential willingness to pay into actual 
revenues. This means that the price of a good must reflect the true 
cost of lost opportunity to society, that is, the value that is given up 
when the good is consumed for a particular use. For the most efficient 
allocation of resources, the social benefits of consuming a particular 
good must exceed the social cost of lost opportunity. It is this total 
cost to society that must be reflected in the price of the goods. 
(3) The characteristics of certain goods and services must be such 
that they do not render them unsuitable for allocation by a private 
market system. One such characteristic is that there is no violation of 
the exclusion principle: pricing demands the possibility of excluding 
nonbuyers from the use of the product. This may be technically im- 
possible or undesirable, as in the case of national defense, where use 
by one person neither diminishes nor excludes availability to others. 
We can generally classify goods that violate these conditions as 
public or collective goods since they are in need of some institutional 
involvement to correct allocative deficiencies of the private market. 
Public goods are most often characterized in the following ways: 
(1) It is impossible to price the good correctly due to difficulties in measuring 
the amount of benefit derived and in translating this into revenues—true social 
cost not reflected in price. 
(2) The basic values of society make it desirable to keep the good out of the 
private market system. Police and fire protection and public education are ex- 
39B Thid., reference 39A; also P. O. Steiner, ‘The Public Sector and the Public Interest,’’ op. cit. 
