1. 30-1 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 30 Public Goods and Public Choice Copyright © 2012 Pearson Prentice Hall. All rights reserved.

2. Pubic Goods and Public Choice Brock Williams P R E P A R E D B Y Here is the text from a TV newscast in the year 2070: “Boomer, the 200-meter asteroid on a collision path with the earth, is expected to land at about 10:00 A.M. in the heart of the world’s breadbasket, the American Midwest. CHAPTER 30 Copyright © 2012 Pearson Prentice Hall. All rights reserved.

3. 30-3 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 30 Public Goods and Public Choice How can we respond to the free-rider problem? Free Riders and the Three-Clock Tower What happens when external benefits spill across international boundaries? Global Weather Observation What private goods generate external benefits? External Benefits from LoJack What happens when neighbors benefit? The Private and External Benefit of Trees What are the implications of the median-voter rule? The Median Voter and Support for Public Schools 1 2 3 4 A P P L Y I N G T H E C O N C E P T S 5

4. 30-4 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 30 Public Goods and Public Choice Public Goods and Public Choice  FIGURE 30.1 Spending Programs for Local, State, and Federal Governments

5. 30-5 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 30 Public Goods and Public Choice Public Goods and Public Choice  FIGURE 30.2 Revenue Sources for Local, State, and Federal Governments

6. 30-6 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 30 Public Goods and Public Choice EXTERNAL BENEFITS AND PUBLIC GOODS 30.1 Public Goods and the Free-Rider Problem ● external benefit A benefit from a good experienced by someone other than the person who buys the good. ● public good A good that is available for everyone to consume, regardless of who pays and who doesn’t; a good that is nonrival in consumption and nonexcludable. ● private good A good that is consumed by a single person or household; a good that is rival in consumption and excludable. ● free rider A person who gets the benefit from a good but does not pay for it.

7. 30-7 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 30 Public Goods and Public Choice EXTERNAL BENEFITS AND PUBLIC GOODS (cont’d) 30.1 Overcoming the Free-Rider Problem Successful organizations use a number of techniques to encourage people to contribute: Giving contributors private goods such as coffee mugs, books, musical recordings, and magazine subscriptions. Arranging matching contributions. Appealing to a person’s sense of civic or moral responsibility. Asteroid Diversion as a Public Good The diversion of asteroids is a public good in the sense that it is available for everyone’s benefit, regardless of who pays and who doesn’t. As with any public good, the key to developing an asteroid-diversion program is to collect money to pay for the program.

8. 30-8 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 30 Public Goods and Public Choice In the days before inexpensive wristwatches, many towns built clock towers to help their citizens keep track of time. ▪ Towns paid for the clock towers with voluntary contributions from citizens. One town built a four-sided tower but put clock faces on only three sides of the tower. ▪ One of the town’s wealthy citizens refused to contribute money to help build the clock tower. ▪ Town officials decided not to put a clock face on the side of the tower facing this citizen’s house. Problem: ▪ Other citizens on the same side of town also suffered from not seeing the clock. ▪ Preventing a free ride by one citizen caused problems for other citizens. FREE RIDERS AND THE THREE-CLOCK TOWER APPLYING THE CONCEPTS #1: How can we respond to the free-rider problem? A P P L I C A T I O N 1

9. 30-9 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 30 Public Goods and Public Choice As another example of a public good, consider global weather observation. In this case, information gathered by one country generates external benefits when it is shared with other countries. Satellites, nomadic buoys, and weather stations monitor weather in different parts of the world, but no single organization gathers all the information to reveal the big weather picture. Another problem is that the uninhabited parts of the world, in particular the vast oceans of the southern hemisphere, receive little monitoring. In recent years, the United States has taken the lead in encouraging cooperation and the sharing of data collected by different organizations around the world. According to the National Oceanic and Atmospheric Administration (NOAA), early warnings of a change in the current in 1997–98 reduced damage to the California economy by about $1.1 billion. GLOBAL WEATHER OBSERVATION APPLYING THE CONCEPTS #2: What happens when external benefits spill across international borders? A P P L I C A T I O N 2

10. 30-10 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 30 Public Goods and Public Choice PRIVATE GOODS WITH EXTERNAL BENEFITS 30.2 External Benefits from Education Education generates three sorts of external benefits: 1 Workplace externalities. When a well-educated person joins a work team, the productivity of everyone on the team increases. 2 Civic externalities. A well-educated person is more likely to vote intelligently, so there are external benefits for other citizens. 3 Crime externalities. Educated people earn higher legal incomes and thus commit less crime.

11. 30-11 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 30 Public Goods and Public Choice PRIVATE GOODS WITH EXTERNAL BENEFITS (cont’d) 30.2 External Benefits and the Marginal Principle  FIGURE 30.3 External Benefits and the Marginal Principle Education (represented here as the number of books read) generates external benefits, so the marginal social benefit exceeds the marginal private benefit. Using books as an example of education, an individual picks point a, where the marginal private benefit equals the marginal cost. Point b is the socially efficient point, where the marginal social benefit equals the marginal cost.

12. 30-12 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 30 Public Goods and Public Choice PRIVATE GOODS WITH EXTERNAL BENEFITS (cont’d) 30.2 External Benefits and the Marginal Principle Other Private Goods That Generate External Benefits The government subsidizes other goods that generate external benefits. Subsidies for on-the-job training and education encourage workers and firms to invest in human capital and increase labor productivity. It is sensible for the government to subsidize training and education because some of the benefits are transferred to other firms when workers change employers. Research at universities and other nonprofit organizations provides knowledge or technology that leads to the development of new products or the improvement of old ones. M A R G I N A L P R I N C I P L E Increase the level of an activity as long as its marginal benefit exceeds its marginal cost. Choose the level at which the marginal benefit equals the marginal cost.

13. 30-13 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 30 Public Goods and Public Choice LoJack is a private good that generates external benefits. A study by two economists estimated the private and external benefits from LoJack: For every three LoJack systems installed, the number of auto thefts decreases by one car per year. The external benefit from fewer vehicle thefts is about $1,300 per LoJack per year. The benefits are experienced by people who don’t buy their own LoJack systems but who benefit because thieves can never be sure whether a particular car is protected by LoJack or not. EXTERNAL BENEFITS FROM LOJACK APPLYING THE CONCEPTS #3: What private goods generate external benefits? A P P L I C A T I O N 3

14. 30-14 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 30 Public Goods and Public Choice Mature trees have private costs and both private and social benefits. The initial cost of purchasing and planting a seedling is low, but the opportunity cost of growing the tree may be large. The benefits of shade, improved air quality, and aesthetics go to the property owner and the neighbors. ▪ The owners house value increases by $7,000. ▪ Neighbors within 100 feet have a total value increase of $13,000. The equilibrium number of trees is less than the socially efficient number, so some cities subsidize the purchase of trees. THE PRIVATE AND EXTERNAL BENEFIT OF TREES APPLYING THE CONCEPTS #4: What happens when neighbors benefit? A P P L I C A T I O N 4

15. 30-15 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 30 Public Goods and Public Choice PUBLIC CHOICE 30.3 Voting and the Median-Voter Rule ●public-choice economics A field of economics that uses models of rational choice to explore decision making in the public sector. ●median-voter rule The choices made by the government will match the preferences of the median voter.

16. 30-16 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 30 Public Goods and Public Choice PUBLIC CHOICE (cont’d) 30.3 Voting and the Median-Voter Rule  FIGURE 30.4 The Median-Voter Rule If Penny proposes a $3 billion budget and Buck proposes a $7 billion budget, the election will result in a tie. By moving toward the median budget, Penny can increase her chance of being elected. In equilibrium, both candidates will propose a budget close to the $5 billion preferred budget of the median voter.

17. 30-17 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 30 Public Goods and Public Choice PUBLIC CHOICE (cont’d) 30.3 The Median Voter and the Median Location  FIGURE 30.5 Competition on a Beach Leads to a Median Location for Both Sellers (A) If one starts at the ¼ mark and one starts at the ¾ mark they each cover ½ mile and each sells 60 cones. (B) If Lefty moves to the 5/8 mark, he sells 75 cones compared to 45 for Righty. (C) Righty can recover by moving to the median location. In equilibrium, both locate at the median mark and split the territory.

18. 30-18 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 30 Public Goods and Public Choice PUBLIC CHOICE (cont’d) 30.3 Alternative Models of Government: Self-Interest and Special Interests Several economists, including Nobel Laureate James Buchanan, have suggested a model of government that focuses on the selfish behavior of government officials. According to this view, politicians and bureaucrats pursue their own narrow interests, which, of course, may differ from the public interest. The self-interest theory of government explains why voters sometimes approve explicit limits on taxes and government spending. According to the self-interest theory of government, limitations on taxes and spending are necessary safeguards against politicians and bureaucrats who benefit from larger budgets. Another model of government is based on the idea that small groups of people manipulate government for their own gain. Whenever benefits are concentrated on a few citizens but costs are spread out over many, we expect special-interest groups to form. Special-interest organizations often use lobbyists to express their views to government officials and policymakers.

19. 30-19 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 30 Public Goods and Public Choice PUBLIC CHOICE (cont’d) 30.3 Which Theory Is Correct? Economists and political scientists have studied many dimensions of the decision-making processes underlying tax policies and spending policies. There is evidence that people do vote with ballots and with their feet, and that these two forms of voting make a difference. There is also evidence that government officials sometimes pursue their own interests and those of special-interest groups. The field of public choice is a very active area of research for both economists and political scientists.

20. 30-20 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 30 Public Goods and Public Choice THE MEDIAN VOTER AND SUPPORT FOR PUBLIC SCHOOLS APPLYING THE CONCEPTS #5: What are the implications of the median-voter rule? Why do voters support public schools? Or, why does the median voter support public schools? The median voter will support public schools it the benefit exceeds the cost. A P P L I C A T I O N 5

21. 30-21 Copyright © 2012 Pearson Prentice Hall. All rights reserved. C H A P T E R 30 Public Goods and Public Choice external benefit free rider median-voter rule private good public-choice economics public good K E Y T E R M S