copyright © 2002 by thomson learning, inc. chapter 4 public goods copyright © 2002 thomson...

Copyright © 2002 by Thomson Learning, Inc.

Chapter 4

Public GoodsCopyright © 2002 Thomson Learning, Inc.

Thomson Learning™ is a trademark used herein under license.

ALL RIGHTS RESERVED. Instructors of classes adopting PUBLIC FINANCE: A CONTEMPORARY APPLICATION OF THEORY TO POLICY, Seventh Edition by David N. Hyman as an assigned textbook may reproduce material from this publication for classroom

use or in a secure electronic network environment that prevents downloading or reproducing the copyrighted material. Otherwise, no part of this work covered by the copyright hereon may be reproduced or used in any form or by any means—graphic, electronic, or mechanical, including, but not limited to, photocopying, recording, taping, Web distribution, information networks, or information storage and retrieval

systems—without the written permission of the publisher. Printed in the United States of America

ISBN 0-03-033652-X


Public Goods are goods for which exclusion is impossible. One example is National Defense: A

military that defends its citizenry from invasion does so for the entire public.

Public Goods


Characteristics of Public Goods

Nonexclusion: The inability of a seller to prevent people from consuming a good when they do not pay for it.

Nonrivalry: The characteristic that if one person “consumes” a good, another person’s pleasure is not diminished nor is another person prevented from consuming it.


Pure Public Goods and Pure Private Goods

Pure Public Good: There is no ability to exclude and there is no rivalry for the benefits.

Pure Private Good: There is a clear ability to exclude and there is rivalry for the benefits.


Marginal Costs for Provision of Public Goods

The marginal cost of allowing another person to benefit from a pure public good is zero while the marginal cost of a greater level of public good is positive.


Figure 4.1 Marginal Costs of Consuming and Producing a Pure Public Good-Figure A

Co

st (

Do

llar

s)

Number of Consumers 0

200

Marginal Cost of Allowing anAdditional Person to Consume aGiven Quantity of Pure Public Good

1


Marginal Cost of Producing a Pure Public Good

Figure 4.1 Marginal Costs of Consuming and Producing a Pure Public Good--Figure B

Units of a Pure Public Good per Year

Co

st (

Do

llar

s)

MC = AC200

0


ExampleBread versus Heat

Bread – Clearly a pure private good because there is the ability to exclude and there is rivalry.

Heat – Clearly a pure public good because there is no ability to exclude and there is no rivalry.


Price Excludable Public Goods

vs

Congestible Public Goods

Provision of Private Good and Public Goods: Markets and

Government


Price Excludable Public GoodsExcludability but no rivalry

Another type of good is a price-excludable public good: no rivalry but exclusion is easy.

Examples: Country Clubs, Cable TV


Congestible Public GoodsRivalry but no excludability

There are public goods where, after a point, the enjoyment received by the consumer is diminished by crowding or congestion. These are called Congestible Public Goods. Examples: roads and parks


Marginal Cost per User

Figure 4.2 A Congestible Public Good

Number of Consumers per Hour 0 1

Mar

gin

al C

ost


CHARACTERISTICSOF THE GOOD OR

SERVICE

MEANS OFPRODUCTION

MEANS OFDISTRIBUTION

METHODSOF

FINANCE

PUBLICEXAMPLE

PRIVATEEXAMPLE

Pure Private GoodsNo externality;low-cost exclusion

Private firms;government

Markets; direct unitcharge

Revenuefrom sales

Food;clothing;cars

Governmentliquor stores;governmenttobaccomonopoly

Government;private firmsunder contractwith government

No direct unit charge;eligibility to consumevarious amountsdetermined politically

Taxes Governmentdistribution ofmedical servicesand food to lowincome citizens

Price-ExcludablePublic GoodsExternal benefitswhen produced orconsumed; low-cost exclusion


Markets; direct unitcharge (may besubsidized)

Revenuefromsales;taxes

Schools;hospitals;transportation

Transit facilities;public hospitals

Government;private firmsunder contractwith government

No direct unit charge;consumption available orrequired only atcollectively chosenquantity and quality

Taxes Public schools;publicsanitation;inoculations

Table 4.1a Alternate Means of Producing, Distributing, and Financing Goods and Services


Table 4.1b Alternate Means of Producing, Distributing, and Financing Goods and Services

CHARACTERISTICSOF THE GOOD OR

SERVICE

MEANS OFPRODUCTION

MEANS OFDISTRIBUTION

METHODS OFFINANCE

PUBLICEXAMPLE

PRIVATEEXAMPLE

Congestible PublicGoodsCollectivelyconsumed benefitssubject tocrowding;possibility ofexclusion


Fees for the right touse the facility sold inmarkets

Revenuefrom sales

Clubs;theaters;amusementparks;sportingevents

Public golfcourses; roads

Government;private firmsunder contractwithgovernment

No direct user charge(or partial charge)

Taxes;revenue fromsales

Public parks;public recreation;roads, bridges

Pure Public GoodsCollectivelyconsumed benefitsnot subject tocrowding; high-cost exclusion

1. Private firms;government2. Government;private firmsunder contractwithgovernment

No direct unit charge;quantity dependent onamount collectedNo direct unit charge;quantity and quality ofservice collectivelychosen

Fees;contributionsTaxes

Privatecharity

Public televisionand radio Nationaldefense;environmentalprotection


A

B

C

H

Exc

lud

abil

ity

Rivalry0

1

1

Figure 4.3 Classifying Goods According to the Degree of Rivalry and Excludability of Benefits from Their Use


Demand For a Pure Public Good

Demand for a Pure Private Good is derived by adding quantities at each price.

Demand for a Pure Public Good is derived by adding how much people will be willing to pay at each quantity.


Pri

ce

per

Lo

af

of

Bre

ad

(D

olla

rs)

Loaves of Bread Purchased per Week

Figure 4.4 Demand For a Private Good

7

6

5

4

3

2

1

0 1 2 3 4 5 9 10 6 87

E S = MC = AC

DC = MBCDB = MBA

DA = MBA

D = QD


Security Guards per Week

Figure 4.5 Demand For A Pure Public Good

Z 1

Z 2

Z 3

Z4

100

200

300

400

500

600

700

800

Mar

gin

al B

enef

it (

Do

llar

s)

0 1 2 3 4 5

DA = MBA

DB = MBB

DC = MBC

DA= MBA


Figure 4.6 Efficient Output for a Pure Public Good

Security Guards per Week

E

100

200

300

400

500

600

700

800

Mar

gin

al B

enef

it (

Do

llar

s)

0 1 2 3 4 5

MBA

MBB

MBC

DA= MBA = MSB

MC = AC = MSB


Efficient Output of a Pure Public Good

The socially optimal level of the public good requires that we set the Marginal Social Benefit of that good equal to its Marginal Social Cost. MSB = MSC

Lindahl Pricing: Everyone in a group cooperates and pays their marginal benefit. We can demonstrate this issue mathematically,

numerically (using a table), and graphically.


Mathematically

Recall from Figure 4.5 that the marginal social benefit for a pure public good is the sum of the individual marginal benefits.

That is: MSB = MB.

Efficient output is therefore:

MSB = MB = MSC.


Numerically

Suppose we have three people who are discussing the issue of hiring security guards. Note that each person places a different value on the levels of security.


Number of Security Guards per Week

1 2 3 4

MBA $300 $250 $200 $150

MBB $250 $200 $150 $100

MBC $200 $150 $100 $50

MB $750 $600 $450 $300If the cost of security guards is $450 per week, then no individual will hire even one guard, even though to group one is worth $750. The group should hire three.

If they pay their marginal benefit, then three guards are hired. Person A pays $600 ($200 per guard), person B pays $450 ($150 per guard) and person C pay $300 ($100 per guard).

A Numerical Example


The Peace Dividend

National Defense is the classic pure public good.

Defense spending as a percentage of GDP Fell from above 8 percent during the Vietnam era

to just above 5 percent in the late 1970s; Grew during the Reagan defense buildup of the

1980s; Fell below 5 percent with the demise of the Soviet

Union.


Public Policy Perspective: Defense Purchases as a Percentage of GDP, 1966–1999

1966

11

10

9

8

7

6

5

1971 1976 1981 1987 1999 1993

Year

Per

cen

tag

e o

f G

DP


Lindahl Equilibrium

The amount each person contributes, ti, depends on their individual desires for the public good.

The sum of the contributions equals the total cost of the public good. tiQ* = MC(Q*) = AC(Q*) ti = MC = AC

All individuals agree to pay their share.


Freeriding

Freeriding occurs when people are not honest in stating their Marginal Benefit because if they understate it, they can get a slightly reduced level of the public good while paying nothing for it.


Freeriding is easier with

Anonymity: If everyone knows who contributes, there can be powerful social stigmas applied to shirkers.

Large numbers of people: It’s easier to determine the shirkers in a small group and the punishment is more profound when people close to you shun you.


Illustrating Voluntary Contributions to a Public Good:

The Gulf War Under the premise that defeating Iraq in the

Gulf War was a public good to be consumed by the industrialized economies and Arab nations, each nation was expected to contribute.

The U.S. and UK contributed the bulk of the fighting forces.

Saudi Arabia, Kuwait, the UAE, Japan, and Germany voluntarily paid $54 billion of the estimated $61 billion cost.

copyright © 2002 by thomson learning, inc. chapter 4 public goods copyright © 2002 thomson...

Documents

public goods copyright

pure public goods

thomson learning

pure public good figure

pure public good demand

pure public good z

provision of public

public finance