1. Public Goods and Public Choice
Chapter 16
Public Goods and Public Choice
© 2006 Thomson/South-Western

2. Introduction Private goods have two important features:
They are rival in consumption – the amount consumed by one person is unavailable for others to consume
They are exclusive – suppliers can easily exclude those who don’t pay

3. Public Goods Nonrival in consumption Nonexclusive
One person’s consumption does not diminish the amount available to others
Once produced, public goods are available to all in equal amount
Marginal cost of providing the good to additional consumers is zero
Nonexclusive
Once a public good is produced, suppliers cannot easily deny it to those who fail to pay  it is nonexclusive
Because they are nonrival and nonexclusive, for-profit firms cannot profitably sell public goods

4. Classification of Goods
Quasi-Public goods
When not congested are non rival
Producers can with relative ease exclude non payers
Open-access goods
Rival but nonexclusive
Fish in the ocean are rival in the sense that once caught they are not available for others to catch
Nonexclusive in the sense that it would be costly or impossible for a private firm to prevent access to these goods

5. Exhibit 1: Categories of Private and Public Goods

6. Optimal Provision of Public Goods
Suppose the public good in question is mosquito control in a neighborhood, which, for simplicity, consists of only two houses
One is headed by Alan and the other by Maria
Alan spends a lot of time in the yard, thus values a mosquito-free environment more than does Maria

7. Exhibit 2: Market for Public Goods
Da and Dm are the demand curves reflecting the marginal benefits that Alan and Maria, respectively, enjoy at each rate of output
How much mosquito spraying should the government provide?
Suppose the marginal cost of spraying is a constant $15 an hour; the efficient level of output is 2 hours per week, where the marginal benefit to the neighborhood equals the marginal cost D 5 2 e
Marginal
cost 10
$15 Da
Dollars per hour Dm D
Hours of mosquito spraying per week

8. Optimal Provision of Public Goods
Efficient approach would be to impose a tax on each resident equal to marginal valuation
Once people realize their taxes are based on how much the government thinks they value the good, people tend to understate their true valuation
Taxpayers are reluctant to offer this information, creating what is called the free-rider problem
Even if the government had accurate information about marginal valuations, some households earn much more than others  a greater ability to pay taxes
Taxing people according to their marginal valuations may be efficient, but it may not be considered fair or equitable

9. Median-Voter Model
Voter whose preferences lie in the middle of the set of all voters’ preferences
The median-voter model predicts that under certain circumstances, the preference of the median, or middle voter will dominate other choices

10. Special Interest and Rational Ignorance
Households have neither the time nor the incentive to understand the effects of public choices on every product
They realize that each of them has only a tiny possibility of influencing the outcome of public choices

11. Special Interest and Rational Ignorance
Rational ignorance: voters remain largely oblivious to the costs and benefits of the thousands of proposals considered by elected officials
The cost to the typical voter of acquiring and acting on such information is usually greater than any expected benefits

12. Distribution of Costs and Benefits
Traditional public-goods legislation
Widespread benefits and widespread costs
Usually has a positive impact on the economy because total benefits exceed total costs
Special-interest legislation
Benefits are concentrated but costs widespread across nearly all consumers and taxpayers
Generally harms the economy, on net, because total costs often exceed total benefits

13. Distribution of Costs and Benefits
Populist legislation
Widespread benefits but concentrated costs
Difficult time getting approved because the widespread group that benefits typically remains rationally ignorant of the proposed legislation  voters provide little political support
Group adversely affected by costs will object
Competing-interest legislation
Involves both concentrated benefits and costs

14. Exhibit 3: Categories of Legislation Based on the Distribution of Costs and Benefits

15. Exhibit 4: Effects of Milk Price Supports
If Congress establishes a floor price of $2.50 per gallon, then the quantity supplied will increase and the quantity demanded will decrease
To maintain the higher price, the government must buy the excess quantity at $2.50 per gallon

16. Rent Seeking
Rents: government transfer or subsidy constitutes a payment to the resource owner that exceeds the earnings necessary to call forth that resource – payment exceeding opportunity cost
The activity that interest groups undertake to elicit these special favors from government is called rent-seeking

17. Rent Seeking
Shifts resources from productive endeavors that create output and income to activities that focus more on transferring income to the special interest
Do nothing to increase output
Frequently reduce output
Special interest groups compete for the same government advantage, so more resources wasted
If the advantage conferred by government requires higher income taxes, the net return individuals expect from working and investing will fall and they may work and invest less

18. Underground Economy
It is reasonably accurate to say that when government taxes productive activity, less production gets reported
The underground economy is a term used for all market activity that goes unreported to the government either to avoid taxes or because the activity itself is illegal

19. Underground Economy A tax on productive activity has two effects:
Resource owners may supply less of the taxed resource because the after-tax wage declines
To evade taxes, some people will shift from the formal, reported economy to an underground, “off-the-books” economy
Tax avoidance is a legal attempt to arrange one’s economic affairs so as to pay the least possible tax
Tax evasion is illegal

20. Bureaucracy Elected representatives approve legislation
The task of implementing legislation is typically left to bureaus

21. Ownership and Funding of Bureaus
Bureaus are typically financed by budget appropriation from the legislature, which comes from taxpayers
Becomes of the differences in the forms of ownership and in the sources of revenue, bureaus have different incentives than do for-profit firms so are likely to behave differently

22. Ownership and Behavior
Government bureaus receive less consumer feedback and have less incentive to act on any feedback they do receive
Government bureaus have less incentive to act on the information available
Profits or losses arising in the bureau are spread among all taxpayers, and because there is no transferability of ownership, bureaus have less incentive to satisfy customers or to produce their output using the least-cost combination of resources

23. Bureaucratic Objectives
The legislature has only limited ability to dig into the budget and cut particular items
If the legislature tries to cut the bureau’s budget, the bureau will threaten to make those cuts as painful to the legislature and constituents as possible
Budget maximization results in a larger budget than that desired by the median voter

24. Private versus Public Production
Simply because some goods and services are financed by the government does not mean that they must be produced by the government
Elected officials may also use some combination of bureaus and firms to produce the desired output
The trend is toward increased privatization  production by the private sector of government provided goods and services

25. Private versus Public Production
Legislators might prefer dealing with bureaus rather than firms for two reasons
The internal organization of the bureau may be more responsive to the legislature’s concerns than the manager of a firm would be
Bureaus provide legislators with opportunities to reward friends and supporters with government jobs