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Social Choice Session 9 Carmen Pasca and John Hey.

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1 Social Choice Session 9 Carmen Pasca and John Hey

2 Public Goods Today we discuss problems with the private provision of public goods. In economics, a public good is a good that is nonrival and non-excludable. Non-rivalry means that consumption of the good by one individual does not reduce availability of the good for consumption by others. Non-excludability that no one can be effectively excluded from using the good. In the real world, there may be no such thing as an absolutely non-rivalled and non-excludable good; but economists think that some goods approximate the concept closely enough for the analysis to be economically useful. We will give some examples later.

3 Plan for today Public and semi-public goods create particular problems for an individualistic society. Because of the goods non-rivalry and non-excludability, individuals have an incentive to free-ride … leading to non- provision. Everyone is worse off than if they were forced to contribute. This result is an obvious argument for state provision… …though there may be other ways around the free-rider problem. We discuss these before concluding that here we have some kind of argument for existence and functioning of the State.

4 But first….. What exactly do we mean by public goods… …and what do we think of as the State and its role. Should it be minimalist (laissez-faire) or interventionist? To provide Defence? Education?/Knowledge? Fundamental Research? Health? Laws? Police? Unemployment benefit? State Insurance of various kinds? Which of these are public goods? Do they have private as well as public elements? Which are provided by the State? What if the State is corrupt? Are they for provision or for redistribution? Is the State involved for economic, social or political reasons? Today we talk solely about public goods and their provision.

5 Public Goods – the Problem A Public Good is one that in non-excludable (people can not be excluded from consuming it) and non-rival (one persons consumption does not diminish what others can consume). Pure examples are rare but close ones exist: lighthouse, national defence, flood control, knowledge, TV, radio. There is a natural (monetary) incentive to free-ride – that is, consume it and let others pay for it. And there is a price – if everyone individually benefits by free- riding, everyone collectively suffers. This seems to be an argument for state provision/existence. But first we explore other ways to ensure provision.

6 An economic issue? Free-riding is usually only considered to be an economic "problem" (as distinct from a social problem concerned with fairness) when it leads to the non-production or under- production of a public good, and thus to Pareto inefficiency, or when it leads to the excessive use of a common property resource. We start with a general description of the public goods game and show why it leads (without public intervention) to the free-rider problem. We consider the simplest version – which shows the problem in its starkest form.

7 Public Goods – the statement of the problem There are N members in society and each has an income m that can either be contributed to the public good or consumed privately. Let x n denote the amount contributed to the public good by individual n and hence (m-x n ) that privately consumed by individual n. Total contributions to the public good are multiplied by some number k (>1) and distributed equally to all. Suppose individual ns utility is simply the sum of his or her private consumption and his or her share of the public good. Then U n = (m-x n ) + k(x 1 + x 2 + x 3 +… + x N )/N What is ns optimal contribution x n ? (Assume k/N<1).

8 The Nash Equilibrium A little bit of maths shows us that, given everyone elses contributions, the best thing for individual n to do is to put x n = 0, that is, to contribute nothing. This is the Nash Equilibrium. (This assumes that k/N 1.) Also we can show that what is collectively best is for everyone contributing everything – that is x n = m. Note: if everyone contributes nothing then everyone gets utility m, whereas if everyone contributes everything then everyone gets utility km – which is much better. But note the incentive problem – in the table on the next slide.

9 An example – from the individual point of view The following table shows ns utility in four cases. We take m=100 and N=10. Also k = 3. n has a very strong incentive to contribute nothing – that is to completely free-ride. But if everyone does this then everyone gets just 100! This is the free-rider problem. ns contribution ns utility/happiness if all others contribute 100 ns utility/happiness if all others contribute 0 10030030 0370100

10 An example – societys point of view The following table follows up the previous example. It supposes that all 10 people in society contribute the same. We take m=100 and k = 3. Everyone in society is better off if everyone contributes everything – despite the private incentives. everyones contributioneveryones utility/happiness 100300 0100

11 Implications Public Goods are goods that are freely available to all – and where one persons consumption of the good does not decrease the consumption of anyone else. We have stated the free-riding problem in its starkest form – and have shown that, if everyone individually decides what to contribute then no-one will contribute anything. But it is best for everyone for everyone to contribute everything. There are ways around the problem, which we discuss in the rest of this lecture. These include: Forced provision and forced payment (what if you do not like it?); Openness – everyone is told what everyone has contributed; Punishment and/or rewards; Threshold; Tax concessions; Voting Groups with identity. Let us look at each of these in turn.

12 Forced Provision First we note that the predictions of the theory have been shown in experiments not to be very good.......people do contribute (though in decreasing amounts). So what do we do? We (The State) can force people to contribute. (Tax?) In a very real sense, this is not a solution. Also it may penalise those who do not wish to consume the good. (Distribution and Poll Tax)

13 Openness We could embarrass people into contributing. Experiments have shown that telling all subjects which subjects have contributed, and how much they have contributed, makes a difference to contributions. This should not make a difference but it does. What is the real world counterpart? Charities that list contributors? Wedding present lists. Does the theory need amending? (Shame? Altruism?) Do we need a State?

14 Punishment and Rewards One proposal – which appears to work – to encourage contributions is to add an extra stage to the which players can punish other players for low contributions or reward others for high contributions. To make sense of this both rewarding and punishing must be costly. But if no-one punishes and/or rewards we are back to the standard public good game. Note however, that someone (The State?) has to propose and implement the rewards and punishments.

15 Tax concessions In a similar vein, the State could propose tax concessions on contributions. This is actually the case in the UK for contributions to charity. An interesting question: How does this work in the context of the standard public goods model? One for the nonna?

16 Thresholds So far we have considered public goods whose provision can be in any positive amount. For certain public goods, there may be a lower bound or a threshold. So the good is provided if and only if contributions cross the threshold. All-or-nothing public goods. This transforms the public goods game (with an inefficient equilibrium) into a coordination game with a set of Pareto-superior equilibria. May work.

17 Majority Voting If I am voting whether the good is to be provided, I cannot free-ride and I need not worry that anyone else can either. We can all vote our overall preferences between supply at the relevant individual cost versus no supply and no cost of provision, so that democratic choice turns our problem into a simple coordination problem - if the majority of us are in agreement that a relevant good should be collectively provided, then under majority voting it will be provided. Is this a good thing?

18 Provision through groups The above analysis has been based firmly on individual action. An alternative approach is one proposed by Mancur Olsen in his book The Logic of Collective Action: Public Goods and the Theory of Groups in 1965. Olsen propounded a novel and influential theory of the behaviour of groups with some collective or common interest. He argued that the smaller the group the better it will further its common interests. Indeed, he argued that one of the most crucial factors in determining whether or not it is possible that the voluntary, rational pursuit of individual interest will bring forth group-oriented behaviour is the size of the group.

19 Olson and groups According to Olson, small groups of people are more efficient and viable than large ones and that action-taking groups and subgroups tend to be smaller than non-action-taking groups and subgroups. Olson has argued that economic incentives are not the only incentives, for instance, people are also motivated by a desire to win prestige, respect, friendship, and other social and psychological objectives. When there are no economic incentives for an individual to contribute to the achievement of a group interest, there might be a social incentive for him or her to make such a contribution. We have noted this elsewhere.

20 Size of the group The idea of group theory is supposed to follow logically from the widely accepted premise of rational self-interested behaviour. According to Olsen, social pressure and incentives operate only in groups of smaller size where members can have face-to-face contact with one another. Olson has come to the conclusion that the larger the group, the less it will further its common interest.

21 Conclusions Without some non-economic considerations or some additions to the issue of contribution to public goods, we have shown that they will not be provided. Groups may somehow collectivise their utilities and co- ordinate their activities. State provision is justified when private provision breaks down. However there are cases (for example, charities) when private provision works. These seem to be where motives are non-economic.

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