Chapter 16 Public Goods and Public Choice © 2009 South-Western/ Cengage Learning

Private, Public Goods, and in Between 1.Private goods –Rival in consumption –Exclusive –Provided by private sector 2.Public goods –Nonrival in consumption –Nonexclusive –Provided by government 2

Private, Public Goods, and in Between 3.Natural monopoly –Nonrival but exclusive –With congestion: private goods –Provided by private sector or government 4.Open-access good –Rival but nonexclusive –Regulated by government 3

Exhibit 1 Categories of goods 4

Optimal Provision of Public Goods Nonrival in consumption –Once produced: available to all consumers Market demand curve –Vertical sum of individual demand curves –Marginal benefit Efficient level of public good –Market D curve intersects MC curve 5

Exhibit 2 Market for public goods $15 Dollars per hour 2 0 Hours of mosquito spraying per week DmDm DaDa Marginal cost D D e Because public goods, once produced, are available to all in identical amounts, the demand for a public good is the vertical sum of each individuals demand. The efficient level :MC of mosquito spraying equals its marginal benefit; at point e, where the marginal cost curve intersects the market demand curve. The market demand for mosquito spraying (D) is the vertical sum of Marias demand, D m, and Alans demand, D a.

Paying for Public Goods Tax = marginal valuation –Free-rider problem People try to benefit from the public goods without paying for them –Ability to pay 7

Public Choice in Representative Democracy Public choices –Government decisions Public goods Taxes Median-voter model –The preference of the median voter will dominate other choices 8

Special Interest and Rational Ignorance Elected officials: Maximize political support –Special interest rather than –Public interest Asymmetry Voters rational ignorance 9

Distribution of Benefits and Costs 1.Widespread benefits; widespread costs –Traditional public-goods legislation –Positive impact on economy Total benefits > total costs 2.Concentrated benefits; widespread costs –Special-interest legislation –Harms the economy Total costs > total benefits –Pork-barrel spending 10

Distribution of Benefits and Costs 3.Widespread benefits; concentrated costs –Populist legislation –Beneficiaries: rationally ignorant 4.Concentrated benefits; concentrated costs –Competing-interest legislation –Fierce political battles 11

Exhibit 3 Categories of legislation based on the distribution of costs and benefits 12

Farm subsidies The Agricultural marketing agreement act, 1937 –Prevent ruinous competition –One in four Americans: farm –Floor prices 2007 –One in fifty Americans: farm $18 billions a year 13

Farm subsidies To subsidize farmers, consumers pay –Higher product price –For the surplus (taxpayers) –For storage (the government buys the surplus) –E.g. milk Free market p=$1.50 Subsidized p=$2.50+$2.50+$0.50 Farmers: normal profit 14

Exhibit 4 Effect of milk price supports Millions of gallons per month $ Dollars per gallon S D Excess quantity supplied No government intervention: market price = $1.50 per gallon, and 100 million gallons are sold per month. Government: floor price = $2.50 per gallon, quantity supplied increases and the quantity demanded decreases. To maintain the higher price, the government must buy the excess quantity at $2.50 per gallon.

Rent Seeking Activity interest groups undertake –Secure special favors from government Political action committees Shift resources from production No incentive for economic efficiency 16

Campaign finance reform Special-interest money Soft money Hard money Money matters more to challengers Efforts to limit campaign spending 17

The Underground Economy Unreported market activity –To avoid taxes –Illegal Tax avoidance –Legal –Pay least possible tax Tax evasion –Illegal –No or fraudulent tax return 18

The Underground Economy Underground economy grows more –Government regulation increase –Tax rates increase –Government corruption widespread Estimated: $1.4 trillion in

Bureaucracy in Representative Democracy Bureaus –Government departments, agencies Ownership –Taxpayers Funding –Government appropriation Less incentive to eliminate waste and inefficiency 20

Bureaucratic objectives –Serve the public –Maximize budget Larger budget than desired by median voter 21 Bureaucracy in Representative Democracy

Private vs. public production –Private production – may be more efficient –Public production – preferred by public officials 22 Bureaucracy in Representative Democracy