1. Public Finance - Introduction
Public goods
Public Finance - Introduction

2. Public Finance - Introduction
Public goods → basic concept to identify conditions in which public sector may potentially outperform private sector in efficiency terms → areas in which government should operate
Useful analytical tool
proxy for general interest goods
Abbreviations:
PG: public good; pg: private good
PS: public sector; ps: public sector
Public Finance - Introduction

3. Public Finance - Introduction
Definition
Pure public good is :
Non rival in consumption
Non excludable
Public Finance - Introduction

4. Definition – Non rivalry
Non rivalry in consumption
Once supplied to ind A → MC of supplying to ind B as well is 0
Es. lighthouse for ships (but Coase, 1974)
Everybody consumes same quantity → this does not mean that everybody gets same MU
E.g. missile defense system. For those who care about security from external threats, MU>0. For a pacifist, MU<0
PG may no longer be so if:
Market situations change (e.g. swimming pool: crowding effect)
Tecnology changes (es. TV signal can now be coded)
Impure PG is rival to a certain extent (es. tourists in front of a view spoil the scenery)
Public Finance - Introduction

5. Definition – Non excludibility
Non excludibility (= joint supply) and non rivalry often in fact coincide but are not the same concept
Non excludibility is on the supply side, non rivalry on the demand side
Non excludibility appears when excluding someone from consumption of a good is too costly
Es. exclusion from city roads is (sometimes) too costly, yet rival insofar as there is traffic
Non excludibility depends on technology
Public Finance - Introduction

6. Public Finance - Introduction
Types of Goods
EXCLUDABLE
RIVAL
YES NO
PRIVATE
GOODS
NATURAL
MONOPOLY
1st click - “Private goods”
2nd click - “Public goods”
3rd click - “Common resources”
4th click - “Natural monopoly”
COMMON RESOURCES
PUBLIC GOODS
Public Finance - Introduction

7. Public Finance - Introduction
Some Public Goods
Basic research
Programs to fight poverty
Uncongested non-toll roads
Fireworks display
Honesty
National Defense
Public Finance - Introduction

8. Definition – some remarks
Many ‘issues’ usually not regarded as goods have characteristics of PGs (es. trustworthiness)
Thurow (1971) → income redistribution is PG
If income distribution is more ‘fair’ (‘equalitarian’?) → everybody benefits from living in a society with fewer tensions
→ Redistribution has non rivalrous characteristics
What’s ‘fair’ ? → disagreement on idea of justice in income distribution
→ Moral value of status quo
pg non necessarily produced by ps
There are pg that are publicly produced (es. medical services)
Nature of the good does not categorically inform about sector of the economy where it is being produced
Distribution of a good in PS does not imply that it also be produced in PS
PS may purchase service from private firms (es. garbage collection, medical services)
Public Finance - Introduction

9. Public Finance - Introduction
Provision of pg
Aggregate demand of pg ‘a’ (rival in consumption) is obtained by horizontal sum
Given Pa → we observe demand (=marginal willingness to pay) of ind 1 and 2
Public Finance - Introduction

10. Efficient Provision of Private Goods
Efficient Provision of Private Goods
Price
Adam (DfA)
Eve (DfE)
Market (DfA+E)
$11 5 1 6 $9 7 3 10 $7 9 14 $5 11 18 $3 13 22 $1 15 26
Public Finance - Introduction

11. Public Finance - Introduction$ Sf
1st click – Adam’s D curve
2nd click – Eve’s D curve
3rd click – sum of Adam and Eve at P = 11
4th click – sum of Adam and Eve at P = 9
5t click – sum of Adam and Eve at P = 7
6th click – sum of Adam and Eve at P = 5
7th click – sum of Adam and Eve at P = 3
8th clck – sum of Adam and Eve at P = 1
9th click - Market Demand curve and dashed horizontal lines disappear
10th click – Market Supply curve
DfA+E
DfA
DfE
Public Finance - Introduction
Quantity of Pizza

12. Pareto Efficiency – Private Goods Case
MRSfa = Pf/Pa
Set Pa = $1
MRSfa = Pf
DfA shows MRSfa for Adam
DfE shows MRSfa for Eve
Sf shows MRTfa
Necessary condition for Pareto efficiency: MRSfaAdam = MRSfaEve = MRTfa
Public Finance - Introduction

13. Efficiency in provision of PG - 1
PG non rivalrous in consumption
Efficiency condition (optimal PG quantity)
MCPG = MBPG
If MCPG=5, and ind1 is willing to pay €2, while ind2 is willing to pay €4, → total MB = €6
MCPG< MBPG → expanding production is efficient
Total MB must be considered because both ind1 and ind2 consume PG (non rivalry)
(5-2)+(8-5)=3+3=6
Sum wrt i [What i benefit – what she would have paid for],
considering price of first unit equal to zero and price of second unit equal to 5.
Public Finance - Introduction

14. Efficient Provision of Public Goods
Efficient Provision of Public Goods
Units of Fireworks 1 2 3 4
Adam (DrA)
$300
$250
$200
$150
Eve (DfE)
250
200
150
100
Market (DfA+E)
$550
$450
$350
Public Finance - Introduction

15. Public Finance - Introduction$ Sr
DrA+E
1st click – Adam’s D curve
2nd click – Eve’s D curve
3rd click – sum of Adam and Eve at Q = 1
4th click – sum of Adam and Eve at Q = 2
5t click – sum of Adam and Eve at Q = 3
6th click – sum of Adam and Eve at Q = 4
7th click - Market Demand curve and dashed horizontal lines disappear
8th click – Market Supply curve
DrA
DrE
Public Finance - Introduction
Quantity of Fireworks

16. Pareto Efficiency – Public Goods Case
MRSfa = Pf/Pa
Set Pa = $1
MRSfa = Pf
DfA shows MRSfa for Adam
DfE shows MRSfa for Eve
Sf shows MRTfa
Necessary condition for Pareto efficiency: MRSfaAdam + MRSfaEve = MRTfa
Public Finance - Introduction

17. Production of PG and free riding
Market does not produce PG in efficient way → ind1 and ind2 have no incentive to reveal their true preferences
free riding → underprovision of PG
Explainable result given non excludability
MC of adding another person to consumption of PG is 0
Efficiency requires MC=P=0 → at P=0 market does not work
Should firm know demand functions of ind1 e ind2
→ perfect price discrimination → market might work
Public Finance - Introduction

18. Public Finance - Introduction
Free riding
Traditional view: Free riding causes failure of market supply
Hence conclusion that government must intervene
Government can somehow “find out” preferences of ind1 and ind2 and use its coercive power to force them to contribute to the financing of PG
es: income taxation → used as proxy for marginal willingness to pay under the hypotheses that ind preces be identical (a contradiction of the hypothesis)
Free riding is not a phenomenon per se → rather a consequence that ind max U
Experimental economics tries to assess generality of free riding
In one shot games free riding is below theory’s prediction; in repeated games free riding becomes more pervasive (Isaac et al. 1985)
Does indoctrination in rational choice influence ind behavior? → Yezer et al. (1996) find students in economics more altruistic, if anything
Public Finance - Introduction

19. Laboratory Experiments: Do People Free-Ride?
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” giving
Public Finance - Introduction

20. Public Finance - Introduction
Prisoner’s dilemma
Cooperating (do not confess) or defecting (confess)?
Nash equilibeium is not PO
Public Finance - Introduction

21. Public and private production
Many goods currently produced in PS can be produced in ps → issue of privatizations
Which criteria to follow?
Relative production costs→ choose the least costly
Administrative costs → PS centralizes them → the higher they are the more efficient is to centralize them
Preferences → the more heterogenous they are, the larger the advantages of ps
Distributive issues→ commodity egalitarism (Tobin, 1970) → PS better (es. education, health care)
Problem: who decides cases of commodity egalitarism?
Public Finance - Introduction

22. Revenues from privatizations, UE countries (1990-2000)
Source: OECD (2002), Paris.
Public Finance - Introduction

23. Privatizations in UE, % GDP, 1990-2000
Source: OECD (2002), Paris.
Public Finance - Introduction

24. Public vs. Private production
Even when a good is held to be supplied in PS → that does not imply it must be also produced in PS
Many believe ps to be more efficient
Managers in PS less penalized if fail to produce efficiently → often not requested to maximize profits
Golden rule of 2 (Mueller, 2003)
Output in PS more difficult to measure
Market condition is what really counts → competition matters more than public or private nature of the firm
Regola aurea del 2: (empirics)Costi spesso pari alla metà
Public Finance - Introduction