McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Chapter 17: Public Goods and Common Resources

17-2 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Objectives After studying this chapter, you will be able to:  Distinguish among private goods, public goods, and common resources  Explain how the free-rider problem arises and how the quantity of public goods is determined  Explain the tragedy of the commons and its possible solutions

17-3 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia A Free Ride and a Tragedy  Why does government provide some goods and services such as the enforcement of law and national defence?  Is the quantity of government-provided services correct?  Why do common resources where everyone is free to use them result in overuse?  These are some of the questions raised in this chapter.

17-4 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Classifying Goods and Resources  A good or service or a resource is:  Excludable if it is possible to prevent someone from enjoying its benefits.  Nonexcludable if it is impossible (or extremely costly) to prevent someone from benefiting from it  Rival if its use by one person decreases the quantity available for someone else  Nonrival if its use by one person does not decrease the quantity available for someone else

17-5 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Classifying Goods and Resources  A Four-Fold Classification  A private good is both rival and excludable  A public good is both nonrival and nonexcludable  A common resource is rival and non-excludable. It can be used only once, but no one can be prevented from using what is available. Example: ocean fish  Marginal cost is zero when buyers can be excluded and are nonrival. Such a good or service is produced by a natural monopoly.

17-6 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Four-fold Classification of Goods Figure 17.1

17-7 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Classifying Goods and Resources  Two Problems of Public goods  Public goods create a free-rider problem – the absence of an incentive for people to pay for what they consume  Common resource create the tragedy of the commons – the absence of an incentive to prevent the overuse and depletion of a resource

17-8 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Public Goods and the Free-Rider Problem  The Benefit of a Public Good  The value of a private good is the maximum amount that a person would pay for one more unit, which is shown by the person’s demand curve.  The value of a public good is the maximum amount that all the people are willing to pay for one more unit of it.  The total benefit of a public good to an individual is the dollar value that a person places on a given level of provision of the good.

17-9 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Public Goods and the Free-Rider Problem  The economy’s marginal benefit curve for a public good is the vertical sum of each individual’s marginal benefit curve.  The demand curve for a private good, is the horizontal sum of the individual demand curves at each price.

17-10 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Benefits of a Public Good Lisa's Marginal Benefit MB L MB M Max's Marginal Benefit 5 5 Quantity (number of satellites) Marginal benefit (dollars per satellite) Quantity (number of satellites) Marginal benefit (dollars per satellite) Figure 17.2

17-11 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Benefits of a Public Good Economy's Marginal Benefit MB Quantity (number of satellites) Marginal benefit (dollars per satellite) Figure 17.2(c)

17-12 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Public Goods and the Free-Rider Problem  The Efficient Quantity of a Public Good  The efficient quantity of a public good is the quantity that maximises net benefit—total benefit minus total cost—which is the same as the quantity at which marginal benefit equals marginal cost.  Figure 17.3 illustrates the efficient quantity.

17-13 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia – The Efficient Quantity of a Public Good QuantityTotal BenefitMarginal BenefitTotal CostMarginal CostNet Benefit (number of(millions(millions of(millions(millions of dollars(millions satellites)of dollars)per satellite)of dollars)per satellite)of dollars) Table 17.3

17-14 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia TB TC MC MB The Efficient Quantity of a Public Good 2.5 Net benefit $4 billion Efficient Use of resources Total Benefit & Total CostMarginal Benefit & Marginal Cost Quantity (number of satellites) Total benefit and total cost (billions of dollars) Quantity (number of satellites) Marginal benefit (billions of dollars per satellite) Figure 17.3

17-15 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Public Goods and the Free-Rider Problem  Private Provision by Market  If a private firm tried to produce and sell a public good, almost no one would buy it.  The free-rider problem results in too little of the good being produced.

17-16 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Public Goods and the Free-Rider Problem  Public Provision  Government can tax all the consumers of the public good and force everyone to pay for its provision. Public provision overcomes the free-rider problem.  If two political parties compete, each is driven to propose the efficient quantity of a public good.  A party that proposes either too much or too little can be beaten by one that proposes the efficient amount, because more people vote for an increase in net benefit.

17-17 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Public Goods and the Free-Rider Problem  The Principle of Minimum Differentiation  The tendency for competitors to make themselves identical to appeal to the maximum number of clients or voters

17-18 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Public Goods and the Free-Rider Problem  The Role of Bureaucrats  Bureaucrats translate the choices of the politicians into programs and control the day-to-day activities that deliver public goods.

17-19 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia TC Bureaucratic Overprovision TB Efficient provision Goal of public servants Quantity (number of satellites) Total benefit and total cost (billions of dollars) Figure 17.4

17-20 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Public Goods and the Free-Rider Problem  Rational Ignorance  The decision not to acquire information because the cost of doing so exceeds the expected benefit.  Voters usually are ignorant about an issue unless that issue perceptively effects the voter’s income.

17-21 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Public Goods and the Free-Rider Problem  Two Types of Political Equilibrium  Two types of political equilibrium—efficient and inefficient. These two types of equilibrium corresponds to two theories of government  Social interest theory.  Public choice theory

17-22 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Public Goods and the Free-Rider Problem  Why Government is Large and Grows  Government grows because the demand for some public goods is income elastic.  Government might be too large because of inefficient over-provision.

17-23 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Public Goods and the Free-Rider Problem  Voters Strike Back  If government grows too large relative to the value voters place on public goods, there might be a voter backlash that leads politicians to propose smaller government.  Privatisation is one way of coping with overgrown government, and is based on distinguishing between public provision and public production of public goods.

17-24 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Common Resources  The Tragedy of the Commons  The tragedy of the commons is the absence of incentive to prevent the overuse and depletion of a commonly owned resource  The original tragedy of the commons has its origin in England from the 14 th century  A Tragedy of the Commons Today  Overfishing—several species of fish have seriously depleted in stock

17-25 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Common Resources  Sustainable Production  Sustainable production is the rate that can be maintained indefinitely  Total Catch  The sustainable rate of production  Average Catch  This refers to the catch per boat which equals the total catch divided by the number of boats  Marginal Catch  The change in the total catch that occurs when one more boat joins the existing number

17-26 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Common Resources  An Overfishing Equilibrium  Overfishing occurs because individuals boat owners consider their marginal benefit and cost, and ignore the social consequences. Figure 17.6 illustrates.

17-27 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia MPB Why Overfishing Occurs 0 Boats (thousands) Sustainable catch per boat (tonnes per month) Overfishing equilibrium MC Marginal cost per boat Catch per boat Figure 17.6

17-28 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Common Resources  The Efficient Use of the Commons  Its is the use of the resource that maximises its sustainable value  The value of the resource is maximised when the marginal cost of using it equals the marginal social benefit from its use  Marginal Social Benefit  The MSB of a boat is the boat’s marginal catch – the increase in the total catch that results from an additional boat

17-29 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia MSB Efficient use of a Common Resource 0 Boats (thousands) Sustainable catch per boat (tonnes per month) MC Efficient use MPB Figure 17.7

17-30 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Common Resources  Achieving an Efficient Outcome  Three main methods might be used to achieve the efficient use of a common resource  Property rights  Quotas  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

17-31 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Quota MSB Using a Quota to Allocate a Common Resource Efficiently 0 Boats (thousands) Sustainable catch per boat (tonnes per month) MC MPB Efficient equilibrium Figure 17.8

17-32 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia MC 1 Individual Transferable Quotas to Use a Common Resource Efficiently 0 Boats (thousands) Sustainable catch per boat (tonnes per month) MC MPB Efficient equilibrium Market price of ITQ Figure 17.9

17-33 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Common Resources  Public Choice and the Political Equilibrium  The method a society chooses for coping with a tragedy of the commons is necessarily a public choice and the outcome of a political process  Efficient Political Outcome  ITQs are examples of efficient political outcome as used by Australia and New Zealand to conserve Southern Bluefin tuna in the South Pacific Ocean  Inefficient Political Outcome  The fishing industries in other countries like the USA and Canada has successfully opposed the introduction of ITQs

17-34 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia END CHAPTER 17