CHAPTER 4 Public Goods McGraw-Hill/Irwin Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.

Characteristics of Goods Excludable vs. Nonexcludable Excludable – preventing anyone from consuming the good is relatively easy Nonexcludable – preventing anyone from consuming the good is either very expensive or impossible Rival vs. Nonrival Rival – once provided, the additional resource cost of another person consuming the good is positive Nonrival – once provided, the additional resource cost of another person consuming the good is zero 1st click – Excludable v Nonexcludable and all sub paragraphs 2nd click – Rival v Nonrival and all sub paragraphs 4

Types of Goods PRIVATE GOODS NATURAL MONOPOLY COMMON RESOURCES 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

Noteworthy Aspects of Public Goods Even though everyone consumes the same quantity of the good, it need not be valued equally by all Classification as a public good is not absolute; it depends on market conditions and the state of technology impure public good A commodity can satisfy one part of the definition of a public good but not the other Some things that are not conventionally thought of as commodities have public good characteristics Private goods are not always provided only by the private sector publicly provided private goods Public provision of a good does not necessarily mean that it is also produced by the public sector

Some Other Public Goods Basic research Programs to fight poverty Uncongested non-toll roads Fireworks display

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

DfA+E DfA DfE $ Sf Quantity of Pizza 1st click – Adam’s D curve 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 Quantity of Pizza 4-7

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

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

DrA+E DrA DrE $ Sr Quantity of Fireworks 1st click – Adam’s D curve 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 Quantity of Fireworks 4-10

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

Problems Achieving Efficiency The Free-Rider Problem Solutions to the free-rider problem Perfect price discrimination Policy Perspective: Global Positioning System Do people free ride?

Laboratory Experiments and Free-Riding 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

The Privatization Debate Privatization – taking services supplied by government and turning them over to the private sector Public v Private Provision: What is the right mix? Relative wage and materials costs Administrative costs Diversity of tastes

Distributional Issues Commodity egalitarianism – notion that some commodities ought to be made available to everyone

Public versus Private Production Efficiency of private production Problems in comparing cost differences Incomplete contracts Competition to supply good or service Reputation building Policy Perspective: Should airport security be produced publicly or privately? Market Environment

Preference Revelation Mechanisms ∆TEve = MRTra – (MRSraTotal – MRSraEve) Eve’s choice: ∆TEve = MRSraEve By substitution: MRTra – (MRSraTotal – MRSraEve) = MRSraEve Add (MRSraTotal – MRSraEve) to both sides: MRTra = MRSraTotal