Market Failure (?): Public Goods & Common Property Dr. D. Foster - Microeconomics

What is “market failure”? When markets fail to achieve allocative and productive efficiency. When do markets fail? Positive externalities Negative externalities Public goods Common property Asymmetric information

Public Goods Non-rival in consumption Non-excludable One person doesn’t use it up. Non-excludable Non-payers can’t be (easily) excluded. For example: National defense Legal system Lighthouses TV and radio Roads

Not all “publicly-provided” goods meet the test of being public goods. For example: Education Trash collection Social security National parks . . . Roads & lighthouses ! The legal system ?!

Public Goods How do markets deal with this problem? Non-excludability problem leads to free riders. How do markets deal with this problem? “Charge” differently - TV & radio ads Find way to exclude - TV & cable/satellite “Tie-in sales - lighthouses - shopping malls - gated communities

Everyone pays the same price, consumes differing amounts Graphical Analysis $10 $5 MC Tom Sally Market 15 25 40 $2 For private goods, the market demand is the horizontal summation of individual demands. Everyone pays the same price, consumes differing amounts

Everyone consumes the same amount, pays differing prices. Graphical Analysis $10 $5 $15 MC Tom Sally Market 20 $8 $3 For public goods, the market demand is the vertical summation of individual demands. Everyone consumes the same amount, pays differing prices.

Government provision may not be desirable Cautions Government provision may not be desirable --The free rider problem is replaced with the forced rider. --Government may be inefficient, imposing higher costs. --Without a profit motive, government may not innovate.

Common Property Weak incentive to preserve/protect. Weak incentive to maximize value. Who owns common property? Fish in the ocean This is another free rider problem.

Common Property Q - Fish Price Supply D1 Q1 Q2 D2 P1 Q* Qmx

Common Property What to do? -- Regulate use . . . - price/tax - standards - limits - prohibit -- Assign private property rights.

Property Rights Coase – As long as transaction costs are low. Not a market problem --Airspace. --Fish. --Endangered species. --Wild species. GroupOn and solving the free rider problem.

Common Property Case Study: The American Thanksgiving In 1620, the Pilgrims arrived on the Mayflower. The Pilgrims “farmed in common” for 3 years. For 3 years they suffered from malnutrition and illness. Then, it was decided to split up the land equally. A bountiful harvest followed (Thanksgiving). Thanksgiving (indirectly) celebrates private property rights!

Elephants & Property Rights Elephants in Africa 1970s - 1.2 million 1980s - 600,000 2014 - 700,000 (e)

Elephants & Property Rights Kenya – ivory burn of 10,000 elephants! [>100 tons]

Can markets really work? Property Rights & nonrenewable resources Can markets really work? S” D S P Q S’ Hotelling Principle: People treat exhaustable resources like any asset and want to max. value over time. The Simple Version - We can’t run out of . . .

Hotelling Principle The more complicated story: Asset value must grow at the market rate of interest to find equilibrium extraction. If asset value grows more slowly, extraction. If asset value grows faster, extraction. i = market return r = asset return r i % Q Q*

Q = amount of oil pumped out of the ground. % r 15% 10% i 7% 4% 0% Q Q1 Q2 Q3 Q* Q = amount of oil pumped out of the ground.

Asymmetric Information -Mutually advantageous trade doesn’t take place. -Trade takes place, but isn’t mutually advantageous. For example: Adverse selection The market for lemons Moral hazard Principal-agent problem

Market Failure (?): Public Goods & Common Property Dr. D. Foster - Microeconomics