Public Goods Many definitions in use Focus on characteristics that might cause resources to be misallocated Not just public provision One of two characteristics: Collective Consumption Nonexcludability

Collective Consumption Goods Consumption by one consumer will not reduce the consumption of any other consumer MC = 0 Example: radio broadcast signal

The Argument for Public Sector Production At efficient output level P=MC MC = 0 for collective consumption good For efficiency, P = 0 Private sector will not produce efficient level of output Solution: Government production at zero price

The Argument for Private Sector Production Lack of congestion might be because of past overproduction Private production provides a revealed price mechanism Public production is financed through taxation Benefits of production vs. excess burden

Congestion of Collective Consumption Goods Collective consumption goods can become congested Collective consumption is an economic concept, not technological Cannot evaluate based on good’s characteristics Example: swimming pool

The Optimal Output of a Collective Consumption Good Private consumption goods Market demand determined by horizontally summing individual demand curves Collective consumption goods Market demand determined by vertically summing individual demand curves

The Optimal Output of a Collective Consumption Good

Lindahl Pricing Set so each individual pays a marginal price equal to the marginal benefit that individual receives Not necessary for the efficient level of output Individuals cannot adjust individual quantity consumed Price does not have to equal consumer’s marginal valuation to be efficient

Lindahl Pricing Advantage: everyone prefers same level of output Increases likelihood that efficient level of output is chosen Practicality? Earmarked gasoline taxes Financing public education through property taxation

Pure and Impure Collective Consumption Goods If each consumer’s consumption share is a function of total output, optimality condition holds regardless whether public or private good Anytime consumer cannot quantity adjusted, optimality condition holds Example: public education

Nonexcludability Once produced, it is difficult to keep people from consuming the good Unrelated to collective consumption Does not have to be publicly provided Example: National defense

Nonexcludability as a Prisoner’s Dilemma Free riding Incentive to benefit from the good without contributing to production Self-interest = everyone free rides Inability to cooperate leads to prisoner’s dilemma

Nonexcludability as a Prisoner’s Dilemma

Nonexcludability and Collective Consumption in Public Goods Public goods embody two characteristics Only one is needed to be a public good Some have elements of both Pure private good Excludable, private in consumption Pure public good Nonexcludable, collective consumption

Nonexcludability and Collective Consumption in Public Goods Pure private good Excludable, private in consumption Pure public good Nonexcludable, collective consumption

Nonexcludability and Collective Consumption in Public Goods

Public Policy Towards Public Goods Public goods do not have to be produced publicly Examples: Microcomputer software Television Radio