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CHAPTER 4

Public Goods

Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

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Characteristics of Goods

• Excludable vs. Nonexcludable – Excludable – preventing anyone from consuming the good is relatively easy

– Nonexcludable – preventing anyone from consuming the good is either very expensive or impossible.

• Impossible or very costly to confine the benefits of the good only to those who pay for the benefits.

• Rival vs. Nonrival – Rival – once provided, the additional resource cost of another person

consuming the good is positive

– Nonrival – once provided, the additional resource cost of another person consuming the good is zero

• Consumption by one person does not diminish the quantity consumed (and benefits received) by another.

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Some Other Public Goods

• Basic research• Programs to fight poverty ; Income distribution• Uncongested non-toll roads• Fireworks display• Weather Forecasting• National Defense• Public health measures• Air• Flood Control / Dam• Lighthouse

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Types of Goods

EXCLUDABLE

RIVALYES NO

YES

NO

PRIVATE

GOODS

PUBLIC

GOODS

COMMON

RESOURCES

NATURALMONOPOLY

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Noteworthy Aspects of Public Goods

• Even though everyone consumes the same quantity of the good, it need not be valued equally by all

• Classification as a public good is not absolute; it depends on market conditions and the state of technology– impure public good: some rivalry and/or excludable to some extent

– Example: TV Broadcasts, Movies, City Streets, Seashore, Restaurant Ratings

• Private goods are not always provided only by the private sector– publicly provided private goods (rival & excludable) Ex: Medical care

• (Public provision of a good does not necessarily mean that it is also produced by the public sector, nor that it is a public good)

– Example: Garbage Collection; park maintenance

– Other examples of goods in which the government hires private companies to do work?

– Other reasons why government might offer good or service such as education? Commodity egalitarianism – notion that some commodities ought to be made available to everyone

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Efficient Provision of Private Goods

Price Adam (Df

A)Eve (Df

A)Market (Df

A+E)$11 5 1

$9 7 3

$7 9 5

$5 11 7

$3 13 9

$1 15 11

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0

1

2

3

4

5

6

7

8

9

10

11

12

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26

DfA

DfE

DfA+E

Sf

$

Quantity of Fig Leaves4-7

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Efficient Provision of Public Goods

Units of Fireworks

1 2 3 4

Adam (DrA) $300 $250 $200 $150

Eve (DfE) 250 200 150 100

Market(Df

A+E)

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050

100

150200250300350400

450500550600650

700750800

1 2 3 4

DrA

DrE

DrA+E

Sr

Quantity of Fireworks

$

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Pareto Efficiency – Private Goods Case

• DfA shows MBf

A for Adam

• DfE shows MBf

E for Eve

• Sf shows MCf

• Necessary condition for Pareto efficiency:

MBfA = MBf

E = MCf

Complete graph on handout!

Note the role prices play for Private Goods: as allocation/rationing devices.

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Pareto Efficiency – Public Goods Case

• DfA shows MBf

A for Adam

• DfE shows MBf

E for Eve

• Sf shows MCf

• Necessary condition for Pareto efficiency:

MBfA + MBf

E = MCf

Complete graph on handout!Note that with Public Goods, prices determine

how the costs of financing PG are to be shared.End of Chapter 4 questions (p. 69-70): #1, 2a, 2c, 4, 11, 13

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Problems Achieving Efficiency

• Financing a Public Good– Benefit Theory of taxation: divide taxes according to

the MB that taxpayers receive. However:• Must know individual demand curve

• Incentive for taxpayers to lie: no incentive to reveal true demand/preferences for public good. Free Rider problem

– Equal Burden taxation: cost divided equally without consideration to benefits

– Other methods (think about fund drives for churches, museums,

libraries, hospitals, sports facilities, NPR): Guilt, emotion; in memorium; “buy a chair/brick”

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Free Rider Problem

• Attempting to avoid bearing the cost of financing a public good.

• Results from the non-exclusion aspect of PG

• Failing to reveal true preferences.

• The larger the group, the more severe is the free rider problem:more likely a public good will not be financed by voluntary contributions.

• Choosing not to contribute is rational behavior.

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Game Theory Model of Financing Public Good

• Each contributor will have only a small effect on the decision to provide the PG or not.

• However, if others feel the same way, PG will not be provided.

• Therefore:– Need government intervention? – Or, are there some preference revealing strategies

• Assignment 3

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Experiments and Free-Riding

• Observations about our game.

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The Privatization Debate

• Privatization – taking services supplied by government and turning them over to the private sector

• Public v Private Provision: What is the right mix?– Relative wage and materials costs– Administrative costs– Diversity of tastes

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Free Ride or Reveal

• Is A better off free-riding or revealing true preferences?

• Is B better off free-riding or revealing true preferences?