Introduction to Microeconomics Chapter 14 Public Goods

Public good a good or service that is both: Non-excludable: non-payers can not be excluded from using it. Non-rival: each unit consumed by one does not its availability for others. Collective good a good or service that, to at least some degree, is non-rival but excludable. Private good a good for which non-payers can easily be excluded and for which each unit consumed by one person means one fewer unit is available for others. Commons good a good for which non-payers cannot easily be excluded and for which each unit consumed by one person means one fewer unit is available for others. Excludability and Rivalry in Consumption (Part I) © 2012 McGraw-Hill Ryerson Limited Ch14 -2 LO1: Types of Goods Based on Rivalry and Excludability

Market Failure Market failure drives the economic rationale for intervention – Occurs when “perfect competition” assumptions fail – Intervention is a benefit cost exercise – the benefits (reduction in social cost) must exceed the cost of intervention – Benefits include reduction in social costs, increased fairness in market outcomes, and increased output – Costs of intervention include crowding out, disincentive effects of tax/financing burden, social/political costs… Main “perfect competition” assumptions: – Costless transactions – Perfect information – Many buyers and sellers – Goods and services “excludable” and “rivalrous” 3 Preliminary results - For discussion only

Externalities Occur when excludability assumption does not hold My activity (production or consumption) affects a second party Externalities can be positive or negative Positive externalities: benefits for third parties, underprovided by the marketplace (e.g., food safety systems such as HACCP can reduce incidence of food-borne disease, but producers may under- invest, especially if they perceive no consequences) Negative externalities: costs for third parties, overprovided by the marketplace (e.g., pollution control results in increased costs which may be easily shifted to other producers/consumers) 4 Preliminary results - For discussion only

Public Goods Occur when excludability and rivalry do not hold 5 Preliminary results - For discussion only Table 1: Levels of excludability and rivalry RivalrousNon-rivalrous Excludable Private goods (wheat, canola, most physical output sold by farmers and processors) Club goods (private parks) Non-excludable Common-pool resources (national fisheries or forests) Pure public goods (air quality, aesthetic value of landscape, biodiversity, agricultural research, and commercialization)

Two reasons favour government provision of public goods. – A private business providing such goods could not collect any payment for costs. “Free-rider” – will let others pay and consume anyway. – Economic surplus issue: Since non-rival good means the marginal cost of serving additional users = zero, it would be inefficient to charge those users, even if charging a price were possible. The only public goods the government should even consider providing are those whose benefits exceed their costs. Pure Public Goods © 2012 McGraw-Hill Ryerson Limited Ch14 -6 LO1: Types of Goods Based on Rivalry and Excludability

Why does government exist? Market failure - regulatory response typical Example: consumer education, fair lending laws, securities regulation... Externalities Example: encourage government to supplement private sector provision of a good or services subsidization of vaccines, public education) and Example: suppression of a bad (pollution). Distributional fairness Example: Laws regarding usury, anti-discrimination legislation Example: Public housing Example: Poverty reduction such as the national child benefit, progressive tax, GST rebate for lower income households

Definition of government initiatives Social marketing to promote a goal (articulation of goal or intent; guidance on preferred behaviour) Expenditures on goods and services Direct resource commitments on goods (public housing, vaccination) Direct resource commitments on services (consumer information, training) Tax expenditures (tax deductions and credits awarded to citizens and businesses to behave, spend, invest, etc.) Grants/contributions/contracts to third parties to perform services Legislation is a general framework for how citizens conduct themselves (smoking bans, criminal code) and requires political assent. Regulation modifies elements of legislation (changes to the speed limit) and can be completed by administrative fiat.

Information Failure Moral hazard – Market participants alter their behaviour in response to the divergence of public and private costs – Taxes/subsidies cause market participants to purchase/sell less/more than would have occurred with prices equal to the marginal cost Asymmetry of information – Sellers are typically more informed than buyers – Prisoners paradox - information lack produces sub- optimal outcomes Uncertainty about other players reactions causes poor decisions – Nash equilibrium exists when I account for your probable reaction to my choices. Equilibrium exists when we have all adjusted and readjusted to each others choices/decisions.

National Child Benefit (NCB) The NCB Initiative is a joint initiative of federal and provincial/territorial governments intended to help prevent and reduce the depth of child poverty, as well as promote attachment to the workforce by ensuring that families will always be better off as a result of working. It does this through a cash benefit paid to low income families with children, a social assistance offset, and various supplementary programs provided by provinces and territories.

National Child Benefit (two children < 18) Net Family Income Benefit Payment CCTB – Base benefit (tax free) that extends to a fairly high income (~$100,000) depending on the number of children under 18 NCB is a top-up for families with low-mid incomes $100,000$33,000$26,000 $6000 All numbers approximate © Greg Mason, 2012 & PRA Inc. 13

provisionproduction Public provision and public production are different issues, because government can and often does sub-contract parts of production. Example: The military often subcontracts aircraft or building maintenance to private firms. Canada’s health care system is a public payer with a mix of public and private suppliers If cost collection from individual users is infeasible, covering the costs of provision means taxation is unavoidable. Paying for Public Goods © 2012 McGraw-Hill Ryerson Limited Ch LO2: How Government Pays for Public Goods

Head tax same amount for every taxpayer. Regressive tax proportion of income paid in taxes declines as income rises. Proportional income tax all taxpayers pay same % of their incomes in taxes. Progressive tax % of income paid in taxes rises as income rises. Types of Taxes: Definitions © 2012 McGraw-Hill Ryerson Limited Ch LO2: How Government Pays for Public Goods

Demand for Private goods Different individuals are free to consume whatever quantity and quality they choose to buy. Total Demand Curve. The amount each person would buy, at a given price, added up over all persons. It is the individual demands summed horizontally. Demand for Public goods Jointly consumed goods must be provided in the same quantity and quality for all persons. Total Demand Curve. The amount each person consumes, added up over all persons, given that amount of public good is produced. It is the individual demands summed vertically. Demand for Private vs. Public Goods © 2012 McGraw-Hill Ryerson Limited Ch LO3: The Optimal Quantity of a Public Good

– To construct the market demand curve for a private good [panel (c)], we add the individual demand curves [panels (a) and (b)] horizontally. FIGURE 14.1: Generating the Market Demand Curve for a Private Good =+ =+ D = D1 + D2 Q Price ($/unit) D1 (a) Q = Q1 + Q2 (c) Price ($/unit) Price ($/unit) D1 (b) Q2 © 2012 McGraw-Hill Ryerson Limited Ch LO3: The Optimal Quantity of a Public Good

To construct the demand curve for a public good [panel (c)], we add the individual demand curves [panels (a) and (b)] vertically. FIGURE 14.2: Generating the Demand Curve for a Public Good D = D 1 + D Q Price ($/unit) (c) (b) Q2Q2 Price ($/unit) 36 D2D2 (a) Q1Q1 Price ($/unit) D1D1 © 2012 McGraw-Hill Ryerson Limited Ch LO3: The Optimal Quantity of a Public Good

The optimal number of hectares of urban parkland is A*, the quantity at which the public’s willingness to pay for additional parkland is equal to the marginal cost of parkland. FIGURE 14.3: The Optimal Quantity of Parkland A0A A* Marginal cost Demand © 2012 McGraw-Hill Ryerson Limited Ch LO3: The Optimal Quantity of a Public Good

The Loss in Surplus from a Pay-per-View Fee Twice as many households would watch the program if its price were zero instead of $10. The additional economic surplus is the area of the blue triangle, or $50 million. © 2012 McGraw-Hill Ryerson Limited LO3: The Optimal Quantity of a Public Good

Rent-seeking LO4: Rent Seeking and Total Economic Surplus © 2012 McGraw-Hill Ryerson Limited Ch Rent-seeking is an attempt to gain economic advantage throuhg social or political manipulation as opposed to creating a selling something unique Licensing of doctors and other professions is a typical example as is supply management cur, rather than by creating new wealt Advocates of these privileges argue that they ensure quality and prevent chests from preying on the public. The license is promoted as an indicator of quality and reduces the time needed to investigate the qualifications of the supplier. Rent seeking is often seen by lobbying to capture privileges stemming from government regulation or potential subsidization.

Polaris Institute, shows key companies and associations of the energy industry met frequently with politicians and senior bureaucrats in recent years to craft common messages and discuss regulatory changes. The report shows that in just one year to this September, senior industry officials held 791 separate meetings with ministers, members of Parliament and officials even as the federal government was pursuing major regulatory changes that critics claim amount to a gutting of environmental protection. Mr. McCarthy noted that over the course of that one year, some 52 of those sessions were with members of cabinet, The most frequent visitors to the government were from the Canadian Association of Petroleum Producers, TransCanada Corp., Imperial Oil Ltd.; the Canadian Energy Pipelines Association, Suncor Energy Corp. and Enbridge Inc. Mr. McCarthy said the energy industry's apparent widespread engagement with government provides ammunition for critics who accuse the government of favouring the resource sector at the expense of the environment. Report co- author Richard Girard said, "To us, this shows a fundamental shift in our democracy from government working for the people to government working for private interests such as industry”(Globe and Mail, B1, 04 December 2012) Who is the Polaris Institute?

14.5 Local, Provincial, or Federal?

Unitary system of Government. – Central government can delegate at will to local authorities, but retains control. Federalism. – Constitution establishes the jurisdiction and powers of each level of government – negotiation and agreement is necessary for any change. Under the Canadian Constitution - Provincial and Federal governments must share power. Common around the world: e.g. USA, Germany, Australia. – Problem: Temptation for politicians - blame other levels of government for all problems. Local, Provincial, or Federal Government? © 2012 McGraw-Hill Ryerson Limited Ch LO5: Roles of Local, Provincial or National Governments

Local government. – A closer match between local preferences and local public policies. Federal government. – Economies of scale in some government services imply cost savings to centralization. Provinces spend more than federal government, since 1970s. – Education and health are the major costs – have been increasing. Federal government has larger tax base. – All federations have inter-governmental transfers of tax revenue to maintain equity and economic surplus within the federation. Local vs. Federal Government © 2012 McGraw-Hill Ryerson Limited Ch LO5: Roles of Local, Provincial or National Governments

Public goods non-rival non- excludable Public goods are, in varying degrees, non-rival and non- excludable. Non-rival Non-rival describes goods for which one person’s consumption does not diminish the amount available for others. Non-excludable Non-excludable refers to the difficulty of preventing non-payers from consuming certain goods. collective good Commons goods A collective good - such as pay-per-view cable television - is non-rival but excludable. Commons goods are goods that are rival but non-excludable. marginal benefit marginal cost The economic criterion for providing the optimal quantity or quality of a public good is to keep increasing quantity or quality as long as the marginal benefit of doing so exceeds the marginal cost. Chapter Summary © 2012 McGraw-Hill Ryerson Limited Ch14 -26

coercion inherent One disadvantage of exclusive reliance on government for public goods provision is the element of coercion inherent in the tax system. public goods private channels Some public goods are provided through private channels, with the necessary funding provided by donations, sale of by-products, by development of new means to exclude non-payers. regulation definition and enforcement of property federal system rights Government serves two other important roles: the regulation of activities that generate externalities and the definition and enforcement of property federal system rights. Canada has a of government and a constitution that establishes the jurisdiction and the powers of both the federal and provincial levels of government. Chapter Summary © 2012 McGraw-Hill Ryerson Limited Ch14 -27