Revision: public goods, commons, and club goods Unit 02

A classification of goods Goods can be classified according to two characteristics: excludability rivalry The existence or absence of these characteristics defines the type of good in question: Rival Excludable yesno ye s Private goodsClub goods no CommonsPublic goods

Type of goodExcludableRival Private goods: - food, clothes etc. - jammed toll roads yes Public goods: - broadcasting services - national defence, education, culture, basic research - free roads without traffic jams no Commons: - fisheries, woods, wild animals - jammed free roads noyes Club goods [Buchanan (1965)] : - cable TV, encrypted TV, internet providers - public utilities: water, gas, telephone services etc. - toll roads without traffic jams yesno

Public goods Public goods are neither excludable nor rival. “free riders”: The main problem with public goods is the existence of “free riders”: individuals who enjoy the advantages of public goods without paying for them. A free rider behaves rationally if goods are non-excludable. This phenomenon and its consequences can be interpreted as the result of an externality: providers of public goods generate a positive externality for those who enjoy them without paying for them.  As a consequence, providers’ costs exceed their profits. This fact discourages the production of public goods. Solution: the State can produce public goods or sponsor private initiatives that provide them, if the social benefit is higher than the social cost.

In deciding whether to provide a public good or not, the State should estimate the monetary value citizens attribute to the public good. (Marshall’s notion of “willingness to pay”) Ex. Citizens would be willing to pay 10 Euros for a firework display. If by rising a tax of 2 Euros on each citizen this service can be financed, the State will decide to provide it. “cost-benefit analysis” This is the domain of “cost-benefit analysis”. The main problem consists in attributing a demand price to goods that have no price and when there is no sufficient incentive to indicate this price (as in the case of private goods). In these cases, we use estimations and conjectures, on an analogical basis.

Commons Commons are not excludable although they are rival. “Tragedy of commons” “Tragedy of commons” (ex. Communal pasture-lands) (Hardin 1968) A common is beneficial common until it is abundant in relation to needs. However abundance generates prosperity and stimulates the growth of the economic activities that exploit them.  the common is exploited too much and becomes sterile. The reason of this result is in the difference between individual and social incentives: users have a collective interest in keeping the exploitation of the resource at a level compatible with its preservation, but they have no individual interest in doing so, since the deterioration of the resource only marginally depends on their activity. Case of externality: everyone produces a negative externality on the others, although he or she does not consider it in deciding what quantity he or she will produce.

Solutions Regulation of maximum producible quantities Selling by auction shares of exploitation of the resource Tax on the exploitation of the resource (it internalises the externality) Subdivision and privatisation of the common (enclosures) In syntesis: -Regulation -Taxation -privatisation

Club goods Club good are excludable and not rival. The fundamental problem of club goods is the choice of the optimum dimension of the club both in terms of the number of members and in terms of the dimension of facilities and services. Increasing members reduces average management costs. Conversely, increasing members generates overcrowding and rivalry. Club membership is voluntary: individuals decide to join a club if they derive a net benefit from it, i.e. a benefit higher than subscription costs.

Examples of club goods Pay TV Golf club Car Park A communication network

The optimum dimension of clubs [1] Members Costs / benefits per member C 1, B 1 = costs and benefits of the smallest facility C h, B h = costs and benefits of the largest facility S 1, S h = optimum members in both cases C1C1 B1B1 S1S1 ChCh BhBh ShSh Case 1. given dimension, variable membership

The optimum dimension of clubs [2] Capacity Costs / benefits per member C 1, B 1 = costs and benefits with a single member C n, B n = costs and benefits with n members Q h = optimum capacity with n members With a single member costs always exceed benefits C1C1 B1B1 CnCn BnBn QnQn Case 2. variable dimension, given members

The optimum dimension of clubs [3] Members Capacity The S line derives from case 1: optimum membership as dimension increases The Q line derives from case 2: optimum dimension as membership increases G = optimum dimension of club G 3. optimum dimension of a club S Q