1 Chapter 4 Public Goods

2 Public Goods are goods for which exclusion is impossible. One example is National Defense: A military that defends one citizen from invasion does so for the entire public. Public Goods

3 Characteristics of Public Goods Nonexclusion: The inability of a seller to prevent people from consuming a good if they do not pay for it. Nonrivalry: The characteristic that if one person consumes a good, another persons pleasure is not diminished, nor is another person prevented from consuming it.

4 Pure Public Goods and Pure Private Goods Pure Public Good: No ability to exclude and no rivalry for benefits. Pure Private Good: Clear ability to exclude and rivalry for benefits.

5 Figure 4.1 Marginal Costs of Consuming and Producing a Pure Public Good-Figure A 0 Cost (Dollars) Number of Consumers 200 Marginal Cost of Allowing an Additional Person to Consume a Given Quantity of Pure Public Good 1

6 Figure 4.1 Marginal Costs of Consuming and Producing a Pure Public Good--Figure B Marginal Cost of Producing a Pure Public Good MC = AC 200 Units of a Pure Public Good per Year Cost (Dollars) 0

7 Price Excludable Public Goods Price-excludable public good: there are external benefits when produced or consumed but exclusion is easy. Examples: Country Clubs, Cable TV

8 Congestible Public Goods 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

9 Figure 4.2 A Congestible Public Good Number of Consumers per Hour 0 Marginal Cost 1 Marginal Cost per User

10 A B C H Excludability Rivalry Figure 4.3 Classifying Goods According to the Degree of Rivalry and Excludability of Benefits from Their Use

11 Demand For a Pure Public Good Market demand for a Pure Private Good is derived by adding quantities demanded at each price. Demand for a Pure Public Good is derived by adding how much people will be willing to pay at each quantity.

12 Figure 4.4 Demand For a Private Good Price per Loaf of Bread (Dollars) Loaves of Bread Purchased per Week E S = MC = AC D C = MB C D B = MB A D A = MB A D = Q D

13 Figure 4.5 Demand For A Pure Public Good Security Guards per Week Marginal Benefit (Dollars) D A = MB A D B = MB B D C = MB C Z 1 Z 2 Z 3 Z4Z4 D= MB A

14 Figure 4.6 Efficient Output for a Pure Public Good Security Guards per Week Marginal Benefit (Dollars) MB A MB B MB C D= MB i = MSB E MC = AC = MSB

15 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

16 Mathematically: Lindahl Pricing 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.

17 Number of Security Guards per Week 1234 MB A $300$250$200$150 MB B $250$200$150$100 MB C $200$150$100$50 MB $750$600$450$300 If the cost of security guards is $450 per week, then no individual will hire even one guard, even though to the group one guard is worth $750. The group should hire three. If they each 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

18 Lindahl Equilibrium The amount each person contributes, t i, depends on individual desires for the public good. The sum of the contributions equals the total cost of the public good. t i Q* = MC(Q*) = AC(Q*) t i = MC = AC All individuals agree to pay their shares.

19 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.

20 Freeriding is easier with Anonymity: If everyone knows who contributes, there can be powerful social stigmas applied to shirkers. Large numbers of people: Its easier to determine the shirkers in a small group and the punishment is more profound when people close to you shun you for not paying your share.