1. Public Goods and Common Resources11
Public Goods and Common Resources

2. The Different Kinds of Goods
Public goods & Common resources
Not excludable: people cannot be prevented from using them (free riders)
Externalities
Public Good: positive externality/benefits for the public, but not compensated for in market
SMB > PMB -> 2 different demand curves
Produce too little when PMB = PMC (Market)
Common property resource: negative externality/costs
PMC < SMC -> 2 different cost curves
Overuse of the resource

3. Criteria Use For Classifying Goods
Excludability – can people be excluded from using the good it they don’t pay for it?
Public Goods (e.g., Fire Station) – NO!
Common Property (e.g., Parks, Fishery) – NO!
Rivalry in consumption
One person’s use diminishes other people’s use
Public Goods – No, one individual’s use does not reduce the amount available to others
Common Property – Yes! (Trees, Fish)

4. Public Goods & Common Property Resources
The free-rider problem (can’t exclude)
Free rider
Person who receives the benefit of a good but avoids paying for it
Public goods – not excludable/non-rival
Once resource is provided, difficult to exclude others from benefitting (and making them pay) for it (e.g., fire station, national defense)
Private market won’t provide enough (economically efficient amount)

5. Education and the social optimum3
Education and the social optimum
Price of
Aluminum
Supply
(private cost)
Social value
(private value
and external benefit)
Optimum
Demand
(private value)
External
Benefit
QOPTIMUM
Equilibrium
QMARKET
Quantity of Aluminum
In the presence of a positive externality, the social value of the good exceeds the private value. The optimal quantity, QOPTIMUM, is therefore larger than the equilibrium quantity, QMARKET.

6. Public Goods & Common Property Resources
Common Property Resource – also not excludable, but is rival in consumption
Can’t exclude others from using/accessing the resource (fish, timber/forests) -> leads to overuse and possible exhaustion of the resource

7. The Different Kinds of Goods
Types of goods
Public goods
Not excludable & Not rival in consumption
Common resources
Rival in consumption & Not excludable
Private goods
Excludable & Rival in consumption
Natural monopoly
Excludable & Not rival in consumption

8. Public Goods Some important public goods National defense
Very expensive public good
Basic research
General knowledge
Fighting poverty
Welfare system
Food stamps
Education

9. Education and the social optimum3
Education and the social optimum
Price of
Aluminum
Supply
(private cost)
Social value
(private value
and external benefit)
Optimum
Demand
(private value)
External
Benefit
QOPTIMUM
Equilibrium
QMARKET
Quantity of Aluminum
In the presence of a positive externality, the social value of the good exceeds the private value. The optimal quantity, QOPTIMUM, is therefore larger than the equilibrium quantity, QMARKET.

10. Correcting for Positive Externalities
Image: Animated Figure 7.2
Lecture tip:
Use flu shots as an example of a behavior with a positive externality.
Easy intuition: the new demand curve (shifted to the right) reflects ALL the benefits rather than just internal benefits.
There is an incentive for people in high risk groups to get vaccinated for the sake of their own health. Looking at the figure, we capture this internal benefit in the demand curve labeled
D internal. However, the market equilibrium, Em, only accounts for the internal benefits of individuals getting vaccinated. In order to maximize the health benefits for everyone, public health officials need to find a way to encourage as many people as possible to get vaccinated. One way is through school vaccination laws. These laws require that all children entering school provide proof of vaccination against a variety of diseases. The overall effect of child vaccination laws are that more people get vaccinated early in life, which reduces the spread of contagious diseases. This creates a positive externality for society.
Government can also promote the social optimum by encouraging economic activity that helps third parties. For example, it can offer a subsidy, or price break, to encourage more people to get vaccinated. The subsidy acts as a consumption incentive. Since the subsidy allows the consumer to spend less money, the willingness to get the vaccine increases. More people are immunized, a result seen in a shift of the demand curve in the figure from D internal to D social. The new demand curve reflects the sum of the internal and social benefits of getting the vaccination. The subsidy encourages consumers to internalize the externality and, as a result, consumption moves from the market equilibrium, Qm, to a social optimum at a higher quantity, Qs.

11. Externalities and Market Inefficiency
Positive externalities
Socially optimal quantity
Greater than market equilibrium quantity
Government – correct market failure
Internalize the externality
Subsidy

12. Effect of a “corrective” subsidy

13. Public Goods The free-rider problem
Public goods – not excludable, non-rival
Free-rider problem prevents the private market from supplying the economically efficient (SMC = SMB) amount of the good
Government - can remedy the problem
If total benefits of a public good > its costs
Provide the public good (or subsidize it)
Pay for it with tax revenue
Make everyone better off

14. Correcting for Externalities
Subsidizing “clean fuels”
Alternative to taxing “dirty” fuels
Help individuals realize external benefits
Finance and/or subsidize production and consumption of the good
Overall consumption is increased, illustrated by a rightward shift in demand
But have to pick the “right fuels”
“What would the market do?”
Subsidize research in new energy
Lecture notes:
Generally, with positive externalities, we know that there are external benefits that individuals may not account for. Thus, we want to increase resource allocation to the activity.
Remember that the demand curve can be thought of as the MB (marginal benefit) curve. Shifting this curve to the right can be thought of as us realizing the extra benefits, so we want to engage in more of this activity.
Laws requiring consumption: everyone has to go to school until the age of 16. Some schools require vaccination records.

15. Are lighthouses public goods?
Decide whether something is a public good
Determine who the beneficiaries are
Determine whether the beneficiaries can be excluded from using the good
A free-rider problem
When the number of beneficiaries is large
Exclusion of any one of them is impossible

16. Public Goods The difficult job of cost–benefit analysis Government
Decide what public goods to provide
In what quantities
Cost–benefit analysis
Compare the costs and benefits to society of providing a public good
Doesn’t have any price signals to observe
See Harris
Government findings on the costs and benefits
Rough approximations at best

17. Cost: $10,000 – new traffic light Benefit: increased safety
How much is a life worth?
Cost: $10,000 – new traffic light
Benefit: increased safety
Risk of a fatal traffic accident
Drops from 1.6% to 1.1 %
Obstacle
Measure costs and benefits in the same units
Put a dollar value on a human life
Priceless = infinite dollar value

18. Put a dollar value on a human life
How much is a life worth?
Put a dollar value on a human life
Implicit dollar value
Courts - award damages in wrongful-death suits
Ignores other opportunity costs of losing one’s life
Risks - people are voluntarily willing to take
Value of human life = $10 million
Cost-benefit analysis
Traffic light
Reduces risk of fatality by 0.5 percentage points
Expected benefit = × $10 million = $50,000
Cost ($10,000) < Benefit ($50,000)
Approve the traffic light

19. The Different Kinds of Goods
Types of goods
Public goods
Not excludable & Not rival in consumption
Common resources
Rival in consumption & Not excludable
Private goods
Excludable & Rival in consumption

20. 1 Four types of goods Rival in consumption? Yes No Excludable?
Private goods
- Ice-cream cones
- Clothing
- Congested toll roads
Natural monopolies
- Fire protection
- Cable TV
- Uncongested toll roads
Common resources
- Fish in the ocean
- The environment
- Congested nontoll roads
Public goods
- Tornado system
- National defense
- Uncongested nontoll roads
Goods can be grouped into four categories according to two characteristics:
(1) A good is excludable if people can be prevented from using it.
(2) A good is rival in consumption if one person’s use of the good diminishes other people’s use of it.
This diagram gives examples of goods in each category.

21. Why the cow is not extinct
Species of animals
Public Goods
Have a commercial value - threatened with extinction
Buffalo
North America
Hunting to near extinction - 19th century (from trains)
Elephants (Ivory)
African countries
Hunting – today
Private good
The cow
Commercial value
Species - continue to thrive

22. Why the cow is not extinct
Elephant - common resource
No owners
Poachers - numerous
Strong incentive to kill them
Slight incentive to preserve them
Cows - private good
Ranches - privately owned
Ranchers
Great effort to maintain the cattle population on his ranch
Reaps the benefit