Chapter Public Goods and Common Resources 11

The Different Kinds of Goods Two criteria for classifying different kinds of goods 1.Excludability Can a person can be prevented from using it? – Yes – Private Good (PMB=SMB, no externality) – No – Public Good or Common Property/Resource » Externality (either SMB > PMB or PMC < SMC) 2. Rivalry in consumption Does one person’s use diminishes other people’s use? – Yes – Private Good – No – Public Good or Common Property 2

Figure Four types of goods 1 3 Rival in consumption? YesNo Excludable? Yes Private goods - Ice-cream cones - Clothing - Congested toll roads Natural monopolies - Fire protection - Cable TV - Uncongested toll roads No Common resources - Fish in the ocean - The environment - Congested nontoll roads Public goods - Tornado system - National defense - Uncongested nontoll roads Goods can be grouped into four categories according to two characteristics: (1) A good is excludable if people can be prevented from using it. (2) A good is rival in consumption if one person’s use of the good diminishes other people’s use of it. This diagram gives examples of goods in each category.

The Different Kinds of Goods Types of goods – Public goods Not excludable & Not rival in consumption – Common resources Rival in consumption & Not excludable – Private goods Excludable & Rival in consumption – Natural monopoly Excludable & Not rival in consumption 4

The Different Kinds of Goods Public goods & Common resources – Not excludable: people cannot be prevented from using them (free riders) – Externalities Public Good: positive externality/benefits for the public, but not compensated for in market – SMB > PMB -> 2 different demand curves » Produce too little when PMB = PMC (Market) Common property resource: negative externality/costs – PMC 2 different cost curves » Overuse of the resource 5

Public Goods The free-rider problem (can’t exclude) Free rider = not excludable Person who receives the benefit of a good but avoids paying for it 1.Public goods = can’t get everyone to pay for benefits derived (e.g., fire protection) Free-rider prevents the private market from supplying the economically efficient as SMB > PMB but people only pay for PMB 2.Common Property Others use of the property degrades productivity -> imposing costs on others (SMC > PMC ) 6

Public Goods The free-rider problem – Government - can remedy the problem If total benefits > costs of a public good, then: 1.Provide the public good (or subsidize it) 2.Pay for it with tax revenue – Makes everyone better off 7

Public Goods Some important public goods – National defense Very expensive public good – Basic research General knowledge – Fighting poverty Welfare system Food stamps – Education 8

Lighthouses (an older example) – Mark specific locations so that passing ships can avoid treacherous waters Benefit - to the ship captain – Not excludable, not rival in consumption Incentive – free ride without paying – Most - operated by the government In some cases – Lighthouses - closer to private goods Coast of England, 19th century – Lighthouses – privately owned and operated – The owner - charged the owner of the nearby port Are lighthouses public goods? 9

Decide whether something is a public good – Determine who the beneficiaries are – Determine whether the beneficiaries can be excluded from using the good A free-rider problem – When the number of beneficiaries is large – Exclusion of any one of them is impossible Are lighthouses public goods? 10

Public Goods The difficult job of cost–benefit analysis – Government Decide what public goods to provide In what quantities – Cost–benefit analysis Compare the costs and benefits to society of providing a public good Don’t have any price signals to observe – See Harris Government findings on the costs and benefits – Rough approximations at best 11

Cost: $10,000 – new traffic light Benefit: increased safety – Risk of a fatal traffic accident Drops from 1.6% to 1.1 % Obstacle – Measure costs and benefits in the same units Put a dollar value on a human life – Priceless = infinite dollar value – Expected future earnings Underestimates – “non-pecuniary” ($) benefits Lower bound (or minimum value) How much is a life worth? 12

Put a dollar value on a human life – Implicit dollar value Courts - award damages in wrongful-death suits – Ignores other opportunity costs of losing one’s life Occupational Risks - people are voluntarily willing to take – Value of human life = $10 million Cost-benefit analysis Traffic light – Reduces risk of fatality by 0.5 percentage points Expected benefit = × $10 million = $50,000 Cost ($10,000) < Benefit ($50,000) Approve the traffic light How much is a life worth? 13

Common Resources Common resources – Not excludable – Rival in consumption The tragedy of the commons – why are common resources used more than is desirable Social and private incentives differ Arises because of a negative externality – Don’t take into account costs imposed on others when equating PMB and PMC 14

Common Resources The tragedy of the commons – Negative externality One person uses a common resource – Diminishes other people’s enjoyment of it Common resources tend to be”overused” – Government - can solve the problem Regulation or taxes – Reduce consumption of the common resource Turn the common resource into a private good – Tradable permits (Individually Transferable Quotas) 15

Common Resources Some important common resources – Clean air and water – Congested roads – Fish, whales, and other wildlife 16

Property Rights Externalities often arise because of a lack of clearly defined property rights. –Ask: Who owns the air? Can I pollute? Private property –Provides exclusive right of ownership that allows for the use and exchange of property –Creates incentive to maintain, protect, and conserve property, as well as listen to the wishes of others

Private Solutions to Externalities The Coase theorem – If private parties can bargain without cost over the allocation of resources They can solve the problem of externalities on their own – Private economic actors Can solve the problem of externalities among themselves – Whatever the initial distribution of rights Interested parties - reach a bargain: – Everyone is better off & Outcome is efficient 18

Private Solutions to Externalities Why private solutions do not always work – High transaction costs Costs that parties incur in the process of agreeing to and following through on a bargain – Bargaining simply breaks down – Large number of interested parties 19

Species of animals – Public Goods Have a commercial value - threatened with extinction – Buffalo » North America » Hunting to near extinction - 19 th century (from trains) – Elephants (Ivory) » African countries » Hunting – today – Private good The cow – Commercial value – Species - continue to thrive Why the cow is not extinct 20

Elephant - common resource – No owners – Poachers - numerous Strong incentive to kill them Slight incentive to preserve them Cows - private good – Ranches - privately owned – Ranchers Great effort to maintain the cattle population on his ranch Reaps the benefit Why the cow is not extinct 21

Government intervention – help elephant population – Kenya, Tanzania, and Uganda (CAC solution) Illegal to kill elephants; Illegal to sell ivory Hard to enforce Elephant population – still diminishing – Botswana, Malawi, Namibia, and Zimbabwe Elephants – private good Allow people to kill elephants – Only those on their own property Landowners - incentive to preserve elephants Elephant population – started to rise Why the cow is not extinct 22