Copyright©2004 South-Western Mod 76 Public Goods & Common Resources

Copyright © 2004 South-Western Recall: Adam Smith’s “invisible hand” of the marketplace leads self-interested buyers and sellers in a market to maximize the total benefit that society can derive from a market. But market failures can still happen. MARKET INEFFICIENCY/FAILURES

Copyright © 2004 South-Western The Nature of Goods Up until now, we have always been looking at “Private” goods…goods allocated in markets through a price and supply and demand… BUT When goods are available free of charge, the market forces that normally allocate resources in our economy are absent

Copyright © 2004 South-Western “The best things in life are free...” When a good does not have a price attached to it, private markets cannot ensure that the good is produced and consumed in the proper amounts.

Copyright © 2004 South-Western “The best things in life are free...” In such cases, government policy can potentially remedy the market failure that results, and raise economic well-being. However, government policy might also create a negative outcome, if policies are not well thought-out or followed.

Copyright © 2004 South-Western THE DIFFERENT KINDS OF GOODS For Public Goods and Common Resources, we have an economic model to use for analysis: It is a matrix that group goods according to two characteristics: Is the good excludable? Is the good rival?

Copyright © 2004 South-Western THE DIFFERENT KINDS OF GOODS Excludability Excludability refers to the property of a good whereby a person can be prevented from using it, usually through a price or charge for it Rivalry or Shared Consumption Rivalry refers to the property of a good whereby one person’s use diminishes other people’s use—in other words, that particular good gets used up

Copyright © 2004 South-Western THE DIFFERENT KINDS OF GOODS Four Types of Goods Private Goods Artificially Scarce Goods—also called “toll goods” Common Resources Public Goods

Four Types of Goods Copyright © 2004 South-Western Rival? OR Shared Consumption? Yes Ice-cream cones Clothing Congested toll roads Fire protection Cable TV Uncongested toll roads Private Goods Artificially Scarce/Toll Goods No Excludable? Fish in the ocean The environment Congested nontoll roads Tornado siren National defense Uncongested nontoll roads Common ResourcesPublic Goods NO—Shared Consumption—YES

Copyright © 2004 South-Western Private Goods and Toll Goods Our experience with them Are they Excludable? They are allocated by having a price, so they ARE excludable Are they Rival? Does my use (owning) of a good “use” that specific good up?

Copyright © 2004 South-Western COMMON RESOURCES Common resources are not excludable. They are available free of charge to anyone who wishes to use them. However…Common resources are rival goods (or NOT shared consumption) because one person’s use of the common resource reduces other people’s use.

Copyright © 2004 South-Western Tragedy of the Commons The Tragedy of the Commons is a parable that illustrates why common resources get used more than is desirable from the standpoint of society as a whole. Common resources tend to be used excessively when individuals are not charged for their usage.

Copyright © 2004 South-Western Some Important Common Resources Clean air and water Fish, whales, and other wildlife

Copyright © 2004 South-Western Solving the Common Resource Issue of a Good being over-used b/c it is non-excludable Governments have several options: Regulate the common resource Apply a tax/fees for use of the common resource Create a system of tradable licenses to use the common resource Make the common resource excludable by assigning private property rights

Copyright © 2004 South-Western PUBLIC GOODS Public Goods are not excludable, AND they have the quality of shared consumption (non- rival) Examples: National Defense Fireworks Lighthouses

Copyright © 2004 South-Western The Free-Rider Problem A free-rider is a person who receives the benefit of a good but avoids paying for it.

Copyright © 2004 South-Western The Free-Rider Problem of Public Goods Free-riders say to themselves: “Why should I pay for something when others can get it for free?” The free-rider problem prevents private markets from supplying these types of goods. No business wants to provide those goods—it is not worth their while—not enough profit!! We want these goods, and no business would offer them as a business good b/c their nature makes them not profitable

Copyright © 2004 South-Western The Free-Rider Problem Solving the Free-Rider Problem The government can decide to provide the public good if the total benefits exceed the costs.

Copyright © 2004 South-Western How a Government Decides to provide a Public Good In order to decide whether to provide a public good or not, the total benefits of all those who use the good must be compared to the costs of providing and maintaining the public good. Cost benefit analysis refers to a study that compares the costs and benefits to society of providing a public good.

Copyright © 2004 South-Western The Difficult Job of Cost-Benefit Analysis A cost-benefit analysis would be used to estimate the total costs and benefits of the project to society as a whole. It is difficult to do because of the absence of prices needed to estimate social benefits and resource costs. The value of life, the consumer’s time, and aesthetics are difficult to assess.

Copyright © 2004 South-Western CONCLUSION: Public Goods and Common Resources When there is a market failure because of the intersection of qualities of excludability and rivalry… Goods will not be produced or allocated efficiently… Then, the government often steps in to try to solve the problem. Such Government Solutions require scrutiny