How should a public good be provided? A transaction cost approach

This paper applies Coase s (1937) theory of the firm to study public good provision. It compares three methods of public good provision: (1) collective provision, where users organize themselves to jointly finance the public good which is produced by a specialized firm; (2) market provision without outsourcing, where a firm produces the public good and a private good, and sells them as a bundle; (3) market provision with outsourcing, where a firm produces a private good, outsources the public good, and sell them as a bundle. All three methods of public goods provision deal with the problem of non-excludability, but each is associated with different transaction costs, organization costs, and specialization economies. The best method is the one which achieves the optimum tradeoffs among transaction costs, organization costs, and specialization economies.