McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. CHAPTER 4 Public Goods

4-2 Characteristics of Goods  Excludable v Nonexcludable Excludable – preventing anyone from consuming the good is relatively easy Nonexcludable – preventing anyone from consuming the good is either very expensive or impossible  Rival v Nonrival Rival – once provided, the additional resource cost of another person consuming the good is positive Nonrival – once provided, the additional resource cost of another person consuming the good is zero

4-3 Types of Goods EXCLUDABLE RIVAL YESNO YES NO PRIVATE GOODS PUBLIC GOODS COMMON RESOURCES NATURAL MONOPOLY

4-4 Noteworthy Aspects of Public Goods  Even though everyone consumes the same quantity of the good, it need not be valued equally by all  Examples?

4-5 Noteworthy Aspects of Public Goods  Classification as a public good is not absolute; it depends on market conditions and the state of technology  Consider a lighthouse – pure public good  Jamming device preventing ships from obtaining the lighthouse signal unless special receiver purchased (excludable)  A scenic view, as congestion rises, nonrivalness criterion no longer satisfied impure public good: is to some extent rival or excludable

4-6 Noteworthy Aspects of Public Goods  A commodity can satisfy one part of the definition of a public good but not the other  Main roads in rush house: nonexcludability holds but consumption is rival. Everyone is trying to get ahead  Exclusion is possible if there are only a few access roads

4-7 Noteworthy Aspects of Public Goods  Some things that are not conventionally thought of as commodities have public good characteristics  Honesty – transactions costs  Fairly distributed income  Information dissemination

4-8 Noteworthy Aspects of Public Goods  Private goods are not necessarily provided exclusively by the private sector publicly provided private goods Medical services Housing

4-9 Noteworthy Aspects of Public Goods  Public provision of a good does not necessarily mean that it is also produced by the public sector  Government can contract out to private firms for the provision of certain public goods  Garbage collection  Fire protection

4-10 Some Other Public Goods  Basic research  Programs to fight poverty  Uncongested nontoll roads  Fireworks display

4-11 Efficient Provision of Private Goods  Horizontal summation for finding the market curve PriceAdam (D f A ) Eve (D f A ) Market (D f A+E ) $11516 $97310 $79514 $ $ $

4-12 DfADfA DfEDfE D f A+E SfSf $ Quantity of Pizza

4-13 Pareto Efficiency – Private Goods Case  MRS fa = P f /P a (from IC and Budget line)  Set P a = $1  MRS fa = P f  Price of figs measures the rate at which Adam is willing to substitute figs for apples  D f A shows MRS fa for Adam  Adams demand curve for figs shows the maximum price per fig leaf that he would pay at each level of fig leaf consumption  D f E shows MRS fa for Eve

4-14 Pareto Efficiency – Private Goods Case  Supply (S f ) shows MRT fa  MRT fa = MC f / MC a  Let MCa =1, so MRT fa = MC f Therefore in pure competition  Pf = MC f (Pareto Efficient)  Necessary condition for Pareto efficiency: MRS fa Adam = MRS fa Eve = MRT fa

4-15 Efficient Provision of Public Goods  Are fireworks a public good or private good?  Nonrival? Nonexcludable? Units of Fireworks 1234 Adam (D r A) $300$250$200$150 Eve (D f E ) Market (D f A+E ) $550$450$350$250

4-16  Once again, prices are being interpreted in terms of MRS as Adam’s willingness to pay for rockets is his MRS  From production standpoint, price represents the MRT

4-17  The MB of the fourth unit is the sum of what Adam and Eve are willing to pay, which is $250  The MC of the fourth unit is the cost of the last unit  If the MB>MC then it should be produced  “Provision of public goods should be expanded until the point at which the sum of each person’s marginal valuation of the last unit just equals the MC”

4-18 Market Demand for Public Goods  Public goods must be consumed in equal amounts, no matter how differently Adam and Eve value each unit  Market demand is the sum of willingness to pay by each consumer for a given quantity  So, instead of horizontal summation, it is vertical summation

4-19 DrADrA Dr E D r A+E Sr Quantity of Fireworks $

4-20 Pareto Efficiency – Public Goods Case  MRS fa = P f /P a  Set P a = $1  MRS fa = P f  D f A shows MRS fa for Adam  D f E shows MRS fa for Eve  S f shows MRT fa  Necessary condition for Pareto efficiency: MRS fa Adam + MRS fa Eve = MRT fa

4-21  Private Good:  MRS (Adam)= MRS(Eve) = MRT  Public Good  MRS (Adam) + MRS(Eve) = MRT  Since everyone consumes the same amount of public good, its efficient provision requires that the total valuation they place on the last unit provided (sum of MRS) equal the incremental cost to society of providing it (MRT)

4-22 Problems Achieving Efficiency  No incentive to lie about how much you value a private good!  The Free-Rider Problem Someone who lets other people pay while enjoying the benefits himself  Excludable consumption, but nonrival Eg. Fireworks display cannot be seen w/o purchasing a ticket. Anyone willing to pay more than 0 can buy ticket. What should you charge?

4-23  Solutions to the free-rider problem Perfect price discrimination A nonrival excludable commodity can be provided privately in case of perfect information  Policy Perspective: Global Positioning System (US military initially did not want civilians to benefit from GPS)  Do people free ride?

4-24 Laboratory Experiments and Free-Riding  How a typical experiment works  Typical results People contribute about 50% of resources to provision of public good Contributions fall the more often the game is repeated Cooperation fostered by prior communication Contribution rates decline when opportunity cost of giving goes up  “Warm-glow” feeling of satisfaction from giving giving

4-25 The Privatization Debate  Privatization – taking services supplied by government and turning them over to the private sector  Public v Private Provision: What is the right mix? Relative wage and materials costs Administrative costs Diversity of tastes

4-26 Public versus Private Production  Efficiency of private production  Problems in comparing cost differences  Incomplete Contracts  Competition to supply good or service  Reputation building  Policy Perspective: Should airport security be produced publicly or privately?  Market Environment

4-27 Distributional Issues  Commodity egalitarianism – notion that some commodities ought to be made available to everyone

4-28 Appendix: Preference Revelation Mechanisms  ∆T Eve = MRT ra – (MRS ra Total – MRS ra Eve )  Eve’s choice: ∆T Eve = MRS ra Eve  By substitution: MRT ra – (MRS ra Total – MRS ra Eve ) = MRS ra Eve  Add (MRS ra Total – MRS ra Eve ) to both sides: MRT ra = MRS ra Total