Public v Private Goods and Information Failures Ch 28

Assume these are the only individuals in the society. Three individuals' demand schedules for a good are shown in the table below. Assume these are the only individuals in the society. Lynn   Mark Pete P Qd $14 1 13 2 12 3 11 4 10 5 9 6 8 7

Write down these questions and I will scroll back to the previous slide. If this is a private good, what is the total quantity demanded at a price of $13? What is the total quantity demanded at a price of $11? Assuming this is a private good whose marginal cost is constant and equal to $10, determine the optimal or efficient quantity of the good. Now assume this is a public good. What is the marginal benefit of the second unit of this good? What is the marginal benefit of the third unit? The fourth unit? If the marginal cost is constant and equal to $30, determine the optimal or efficient quantity of this public good.

Answer: For a private good, the total quantity demanded is the sum of the quantities demanded by each of the three individuals at a given price. At a price of $13, the total quantity demanded is 3: 2 from Lynn, 0 from Mark, and 1 from Pete. At a price of $11, the total quantity demanded is 4 + 1 + 3 = 8. The optimal amount occurs where price and marginal cost are equal. Since marginal cost is $10, price must be $10. At this price, the total quantity demanded is 5 + 2 + 4 = 11 units. Public Good The marginal benefit of any particular unit is the sum of the values placed on that unit by each of the individuals. In this example, the marginal benefit of the second unit is $35: $13 by Lynn, $10 by Mark, and $12 by Pete. The marginal benefit of the third unit is $12 + $9 + $11 = $32. The marginal benefit of the fourth unit is $11 + $8 + $10 = $29. Comparing marginal benefit to marginal cost, the third unit should be provided, as its marginal benefit of $32 exceeds its marginal cost of $30. However, the fourth unit should not be provided as its marginal benefit is less than its marginal cost: $29 < $30.

Involving Sellers Leads to underallocation of resources Consumers worry about sellers that cheat and must get more information about the market. Marginal cost of obtaining information about sellers would be high, leading to underallocation of resources. Governments intervene in these market failures Examples: gasoline and surgery

If there was no licensing would you let this doctor do surgery on you?

Involving buyers Private markets may underallocate resources to a particular good or service for which there is a moral hazard problem: the tendency of one party to a contract or agreement to alter behavior in ways that could be costly to the seller. It arises after the contract is signed Example: driver engages in riskier behavior after taking out insurance Information known by one party is not known by the other is an example of adverse selection. It arises before or when the contract is signed. Example: person who knows he/she is very sick takes out a large life insurance policy. Example: Obamacare may succeed or fail based on the adverse selection problem.