Property Rights and Public Goods

Overview Externalities and Property Rights Common Property Resources Recycling Common Property Resources Public Goods & Private Preferences for Public Goods Benefit-cost Analysis Public Choice Process 2

The Efficient Amount of Recycling Cost With a refundable deposit, MC increases and MC = MSC = MCR. MC + per unit refund MC m1 Without market intervention the level of scrap will be at m1 and m1 > m*. Households can dispose of glass and other garbage at very low cost. The low cost of disposal creates a divergence between the private and the social cost of disposal. S0, raising MC is a move in the right direction. MCR MSC m* Refund is like a tax for non-compliance, but no tax if there is compliance Scrap 4 8 12 Extent of recycling 75

With refunds Sr increases to S’r and S increases to S’. Refundable Deposits S’r S’ P’ M* With refunds Sr increases to S’r and S increases to S’. Sv Sr S The supply of glass S is the horizontal sum of the Supply of virgin glass (Sv) and the supply of recycled glass (Sr). $ M1 P Without refunds the price of glass is P and Sr is M1. D Price falls to P’ and the amount of recycled glass increases to M*. Amount of Glass 80

Externalities and Property Rights Legal rules describing what people or firms may do with their property For example If residents downstream owned the river (clean water) they control upstream emissions. Bargaining and Economic Efficiency Economic efficiency can be achieved without government intervention when the externality affects relatively few parties and when property rights are well specified. 81

PRIVATE SOLUTION TO EXTERNALITIES Coase Thorem: Economic agents can arrive at an efficient solution (i.e., an optimum assignment of property rights) irrespective of initial assignment of property rights, provided they can bargain free of cost (i.e., w/o transaction costs), and there is no wealth effect to thwart the bargaining process. Coase Theorem at Work: Negotiating an Efficient Solution - 1987 --- New York garbage spill (200 tons) littered the New Jersey beaches The potential cost of litigation resulted in a solution that was mutually beneficial to both parties.

Coase Theorem MC of pollution abatement by factory MC of pollution to fisheries OE is optimal quantity of pollution and O’E is the corresponding optimal quantity of abatement At E, the marginal costs of pollution and abatement are equal, and the sum of the total costs i.e. triangle OXO’ is the least At A, MC of abatement exceeds MC of pollution, so it is cheaper to compensate the fishermen AB than to abate the pollution AC C L Demand price for abatement now higher to facilitate pollution reduction X Demand price for abatement falls short B O O’ A E F Pollution Abatement

Common Property Resources Everyone has free access. Likely to be over-utilized Examples Air and water Fish and animal populations Minerals Solution Private ownership Question Wouldn’t private ownership be impractical? 94

Common Property Resources Private Cost FC Without control the number of fish/month is FC where PC = MB (marginal benefit). Benefits, Costs ($ per fish) However, private costs underestimate true cost. The efficient level of fish/month is F* where MSC = MB (D) Marginal Social Cost F* Demand Fish per Month 98

Crawfish Fishing in Lousiana Finding the Efficient Crawfish Catch F = crawfish catch in millions of pounds/yr C = cost in dollars/pound Demand C = 0.401 = 0.0064F MSC C = -5.645 + 0.6509F PC C = -0.357 + 0.0573F Efficient Catch 9.2 million pounds D = MSC

Crawfish as a Common Property Resource Cost (dollars/pound) Marginal Social Cost Private Cost 11.9 2.10 9.2 0.325 Demand Crawfish Catch (millions of pounds) 98

Public Goods Public Good Characteristics Non-rival For any given level of production the marginal cost of providing it to an additional consumer is zero. Non-exclusive People cannot be excluded from consuming the good. Not all government produced goods are public goods Some are rival and non-exclusive (more like a common property resource) Education 101

Common Property Resource Typology of Goods Characteris-tics Excludable Non-excludable Rival Private Good Common Property Resource Non-rival Club Good Public Good

Efficient Public Good Provision Benefits (dollars) D1 D2 D When a good is non-rival, the social marginal benefit of consumption (D) , is determined by vertically summing the individual demand curves for the good. $7.00 $5.50 Marginal Cost $1.50 Efficient output occurs where MC = MB at 2 units of output. MB is $1.50 + $4.00 or $5.50. $4.00 Horizontal sum of demand curves What if this is the MC curve? Output 1 2 3 4 5 6 7 8 9 10 105

Problem with Public Goods Free Riders There is no way to provide some goods and services without benefiting everyone. Households do not have the incentive to pay what the item is worth to them. Free riders understate the value of a good or service so that they can enjoy its benefit without paying for it. Clean Air is a public good Non-exclusive and non-rival What is the price of clean air? 107

How to know Private Preferences for Public Goods? Government production of a public good is advantageous because the government can assess taxes or fees to pay for it. Determining how much of a public good to provide when free riders exist is however extremely difficult. 114

The Demand for Clean Air Dollars Low Income Middle Income High Income 3000 2500 2000 1500 1000 500 Nitrogen Oxides (pphm) 1 2 3 4 5 6 7 8 9 10 112

Findings on Demand for Clean Air Amount people are willing to pay for clean air increases substantially as pollution increases. Higher income earners are willing to pay more (the gap between the demand curves widen) National Academy of Sciences found that a 10% reduction in auto emissions yielded a benefit of $2 billion---somewhat greater than the cost. 113

Exercise 7, p.653: Willingness to pay for different quantities of the public good Time G-1 G-2 G-3 V.Sum 0 150 200 250 600 50 100 100 200 400 100 50 0 150 200 150 0 0 100 100 200 0 0 50 50 250 0 0 0 0

Exercise 7, p.653: Willingness to demand the private good at different prices Price G-1 G-2 G-3 H.Sum 250 0 0 0 0 200 0 0 50 50 150 0 25 100 125 100 50 50 150 250 50 100 75 200 375 0 150 100 250 500

Benefit-cost Analysis Compares present value of benefits to present value of costs of a government project, which is mostly in the nature of public goods Helps ranking projects in terms of benefit-cost ratio (must be >1) until available limited resources are exhausted Difficulties in BC ratio estimation: Correctly estimating benefits & costs in the future, especially their opportunity costs Many benefits and costs - often in the nature of intangibles - are not quantifiable Choice of interest rate for discounting poses a very serious problem & hence sensitivity analysis is performed to choose across different alternative rates Hence, BC analysis still a subjective art rather than an objective science

Public Choice Process Broad groups Major characteristics 1. Voters Voting for policies favoring their interests Generally less informed about political decisions than their market decisions – referred to as ‘rational ignorance’ - less need to gather information as elected leaders are empowered to take decisions on their behalf - very expensive to gather information on public choice - voters have less influence on and lesser affected by public choice as compared to market choice 2. Politicians As counterpart of firm entrepreneurs/managers, seek to maximize chance of re-election Often responds to desires of small, well-organized, well-informed, well-funded, passionate & vocal interest groups at the cost of mostly silent and uninformed majority

Public Choice Process Broad groups Major characteristics 3. Interest groups Organize lobbies and support politicians willing to serve their interests, although laws & regulations are invariably rationalized in terms of national interest 4. Bureaucrats Often implements policies under monopoly conditions w/o caring for efficiency, unless there is pressure of competition to compete and coordinate Often non-neutral and non-passive, actively trying to influence policy & its implementation Hence as a special interest group within government contributes to size & growth of the bureau

Some Institutional Changes Suggested to prevent ‘Government Failure’ Informing, educating & organizing voters Contracting out government services not entirely public good in nature Encouraging inter-agency competition Referendum & thus frequently reverting to direct democracy Specify total amount of funds to be allocated across competing uses.