When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Distinguish among private goods, public goods, and common resources. 1 Explain the free-rider problem and how public provision can help to overcome that problem. 2 Explain the problem of the commons and review the possible solutions to that problem. 3

10.1 CLASSIFYING GOODS AND RESOURCES What is the essential difference between: A city police department and Brinks security Fish in the Atlantic Ocean and fish in a fish farm A live concert and a concert on television These, and all goods and services can be classified according to whether they are excludable or nonexcludable and rival or nonrival.

Excludable A good, service, or resource is excludable if it is possible to prevent a person from enjoying its benefits. Nonexcludable A good, service, or resource is nonexcludable if it is impossible to prevent a person from enjoying its benefits CLASSIFYING GOODS AND RESOURCES

Examples of excludable items are: The services of Brinks security Fish in a fish farm A live concert Examples of nonexcludable items are: The services of the city police department Fish in the Atlantic Ocean A broadcast television signal 10.1 CLASSIFYING GOODS AND RESOURCES

Rival A good, service, or resource is rival if its consumption by one person decreases its consumption by other people. Nonrival A good, service, or resource is nonrival if its consumption by one person does not decrease its consumption by other people.

Examples of rival items are: The services of Brinks security Fish both in ocean and in a fish farm A seat at a live concert Examples of nonrival items are: The protection provided by a city police department A broadcast television signal 10.1 CLASSIFYING GOODS AND RESOURCES

Private good A good or service that can be consumed by only one person at a time and only by those people who have bought it or own it. Public good A good or service that can be consumed simultaneously by everyone and from which no one can be excluded. A Four-Fold Classification

10.1 CLASSIFYING GOODS AND RESOURCES Common resource A resource that is nonexcludable and rivalcan be used only once but no one can be prevented from using what is available. Natural monopoly A good or service that is nonrival but excludablecan be produced at zero marginal cost. A Four-Fold Classification

Figure 10.1 shows this four-fold classification of goods and services CLASSIFYING GOODS AND RESOURCES

Public goods create a free-rider problem. Free rider A person who enjoys the benefits of a good or service without paying for it. Because of the free-rider problem, the market would provide too small a quantity of a public good. To produce the efficient quantity, government action is required PUBLIC GOODS 10.2 PUBLIC GOODS AND FREE RIDER PROBLEM The Free-Rider Problem

The benefit a public good provides is the value of its services. Because satellite services are nonrival and nonexcludable, they are a public good. Everyone consumes the same quantity of them. To find the economy wide value of the satellites, we add together the marginal benefits of everyone in the economy. The Marginal Benefit of a Public Good 10.2 PUBLIC GOODS AND FREE RIDER PROBLEM

Figure 10.2 shows how to find an economys MB curve. Lisas marginal benefit curve is MB L. The MB curve for the economy is the vertical sum of the marginal benefit curves of everyone in the economy. Maxs marginal benefit curve is MB M PUBLIC GOODS AND FREE RIDER PROBLEM

Marginal cost increases as the quantity of satellites produced increasesthe principle of increasing marginal cost. So the marginal cost curve of satellites slopes upward. The Marginal Cost of a Public Good 10.2 PUBLIC GOODS AND FREE RIDER PROBLEM

The Efficient Quantity of a Public Good Resources are used efficiently if marginal benefit equals marginal cost. If marginal benefit exceeds marginal cost, resources can be used more efficiently by increasing the quantity produced. If marginal cost exceeds marginal benefit, resources can be used more efficiently by decreasing the quantity produced PUBLIC GOODS AND FREE RIDER PROBLEM

Figure 10.3 shows the efficient quantity of a public good. 1. If MB exceeds MC, an increase in the quantity will make resource use more efficient. 2. If MC exceeds MB, a decrease in the quantity will make resource use more efficient PUBLIC GOODS AND FREE RIDER PROBLEM

3. If MB equals MC, resource use is efficient. 4. The efficient quantity is 200 satellites PUBLIC GOODS AND FREE RIDER PROBLEM

No one would have an incentive to buy his or her share of the satellite systemthe free-rider problem. So a private firm would not supply satellites. Private Provision The political process determines the quantity of a public good provided. Public Provision 10.2 PUBLIC GOODS AND FREE RIDER PROBLEM

Figure 10.4(a) shows the preferences of two political parties in an election. 1. Doves would like to provide 100 satellites. 2. The Hawks would like to provide 300 satellites PUBLIC GOODS AND FREE RIDER PROBLEM

Figure 10.4(b) shows an efficient political outcome. 3. The political outcome is 200 satellites because, unless each party proposes 200 satellites, the other party can beat it in the election PUBLIC GOODS AND FREE RIDER PROBLEM

Principle of minimum differentiation The tendency for competitors to make themselves identical to appeal to the maximum number of clients or voters. Principle of Minimum Differentiation 10.2 PUBLIC GOODS AND FREE RIDER PROBLEM

Bureaucrats translate the choices of politicians into programs and control the day-to-day activities that deliver public goods. The behavior of bureaucrats modifies the political outcome. Rational Ignorance The decision not to acquire information because the marginal cost of doing so exceeds the expected marginal benefit. The Role of Bureaucrats 10.2 PUBLIC GOODS AND FREE RIDER PROBLEM

Government grows in part because the demand for some public goods increases at a faster rate than the demand for private goods. Two possible reasons are: Voter preferences Inefficient overprovision Why Government Is Large and Grows 10.2 PUBLIC GOODS AND FREE RIDER PROBLEM

Voter Preferences As voters incomes increase, the demand for many public goods increases more quickly than income. These goods include: Highways; air-traffic control systems; public health; education; and national defense. Inefficient Overprovision The goal of budget maximization combined with voters rational ignorance might explain the expanding government budgets PUBLIC GOODS AND FREE RIDER PROBLEM

A backlash against government programs might force politicians of all parties to embrace smaller and leaner government. Privatization of the production of public goods might also counter the tendency for government budgets to grow. Voter Backlash 10.2 PUBLIC GOODS AND FREE RIDER PROBLEM

10.3 COMMON RESOURCES The Problem of the Commons The problem of the commons is the absence of incentives to prevent the overuse and depletion of a commonly owned resource. Examples include the Atlantic Ocean cod stocks, South Pacific whales, and the quality of the earths atmosphere. The traditional example from which the term derives is the common grazing land surrounding middle-age villages.

10.3 COMMON RESOURCES Figure 10.5 illustrates production possibilities from a common resource. As the number of fishing boats increases, the quantity of fish caught increases to some maximum. Beyond that maximum, the sustainable catch decreases.

10.3 COMMON RESOURCES Figure 10.6 shows why a common resource get overused. 1. The average catch per boat, which is the marginal private benefit, MPB, decreases as the number of boats increases. 2. The marginal cost per boat is MC (assumed constant).

10.3 COMMON RESOURCES 3. Equilibrium occurs where marginal private benefit, MPB, equals marginal cost, MC. In equilibrium, the resource is overused because no one takes into account the effects of her/his actions on other users of the resources.

10.3 COMMON RESOURCES The Efficient Use of the Commons The quantity of fish caught by each boat decreases as the number of boats increases. But no one has an incentive to take this fact into account when deciding whether to fish. The efficient use of a common resource requires marginal cost to equal marginal social benefit.

10.3 COMMON RESOURCES Marginal Social Benefit Marginal social benefit is the increase in total fish catch that results from an additional boat, not the average catch per boat. Table 10.1 on the next slide shows the calculation of marginal social benefit.

10.3 COMMON RESOURCES BoatsTotal CatchMSB A00 90 B1 70 C D E4240

10.3 COMMON RESOURCES Efficient Use Figure 10.7 illustrates the efficient use of a common resource. 1. The marginal social benefit curve, MSB, is below the MPB curve. 2. The resource is used efficiently when MSB equals MC.

10.3 COMMON RESOURCES Achieving an Efficient Outcome It is harder to achieve an efficient use of a common resource than to define the conditions under which it occurs. Three methods in use are: Property rights Quotas Individual transferable quotas (ITQs)

10.3 COMMON RESOURCES Property Rights By assigning property rights, common property becomes private property. When someone owns a resource, the owner is confronted with the full consequences of her/his actions in using that resources. The social benefits become the private benefits.

10.3 COMMON RESOURCES In Figure 10.7, the marginal social benefit curve, MSB, becomes the marginal private benefit curve. The resource is used efficiently because the owner of the resources is best off when MSB equals MC.

10.3 COMMON RESOURCES Quotas By assigning setting a production quota at the efficient quantity, a common resource might remain in common use but be used efficiently. Figure 10.8(a) shows this situation. It is hard to make a quota work.

10.3 COMMON RESOURCES Individual Transferable Quotas An individual transferable quota (ITQ) is a production limit that is assigned to an individual who is free to transfer the quota to someone else. A market emerges in ITQs. If the efficient quantity of ITQs is assigned, the market price of a quota confronts resource users with a marginal cost that equals MSB at the efficient quantity.

10.3 COMMON RESOURCES Figure 10.8(b) shows the situation with an efficient number of ITQs. Marginal cost rises from MC 0 to MC 1. Users of the resource make marginal private benefit, MPB, equal to marginal private cost, MC 1, and the outcome is efficient.