1)Why is national defense called a public externality?

2)An apartment owner advertises for lawn mowing services for a number of apartments he owns. He has some idea of the going price and so he advertises that he will pay $100 per month per apartment complex. So why is he disappointed that the winning contractor only provides minimal services? (Keyword for the answer is adverse selection.)

1)Public goods are goods that have two important characteristics:

1) Non-rivalry: this implies that many consumers can consume the good at the same time.

2) Non-excludability: this implies than no agent can exclude another from consuming the good.

In consequence, the problem with public goods is that no private firm is willing to produce it, since no consumer is willing to pay for it. Indeed, nobody would pay for this good, since everybody knows that if only one agent pays, then all the rest can consume it for free.

This possibility to consume it for free is called "free-riding" and constitutes an externality for those who did not pay for the good.

National defense is considered a pure public goods, since it is impossible to provide this good for only some people and not the rest. National defense is non-rival and non-excludable and, hence, no consumer is willing to pay for it. In consequence, only the government can provide this good, which constitutes a public externality for the whole population.

2) By offering fixed price, the apartment owner only attracted contractors who add value at or below the advertised price. Contractors would not seek out his contract and thus he is getting adversely selected against. He doesn't know much about the contractors but they know what service/value they add. This leads to the apartment owner getting a worse service than he paid for. He should have put in his contract minimum expectations that if not met would null the job.