Economic Analysis for Business Session XVIII: Public Goods and Common Resources Instructor Sandeep Basnyat

The best things in life are free... Free goods provide a special challenge for economic analysis. When goods are available free of charge, the market forces that normally allocate resources in our economy are absent. Do you actually need this much to eat? Where is the theory of Demand and Supply?

THE DIFFERENT KINDS OF GOODS When thinking about the various goods in the economy, it is useful to group them according to two characteristics: Is the good excludable? Is the good rival?

THE DIFFERENT KINDS OF GOODS Excludability Excludability refers to the property of a good whereby a person can be prevented from using it. Rivalry Rivalry refers to the property of a good whereby one persons use diminishes other peoples use.

THE DIFFERENT KINDS OF GOODS Four Types of Goods Private Goods Public Goods Common Resources Natural Monopolies

THE DIFFERENT KINDS OF GOODS Private Goods: Private Goods: Both excludable and rival.

THE DIFFERENT KINDS OF GOODS Public Goods: N Public Goods: N either excludable nor rival. Street Lights National Defense Court room services

THE DIFFERENT KINDS OF GOODS Common Resources: R Common Resources: R ival but not excludable. Fish in the Ocean People in the public park

THE DIFFERENT KINDS OF GOODS Natural Monopolies: Natural Monopolies: Are excludable but not rival. Cable TV Telecommunication Services

PUBLIC GOODS: Problem A free-rider is a person who receives the benefit of a good but avoids paying for it. The free-rider problem prevents private markets from supplying public goods.

The Free-Rider Problem Solving the Free-Rider Problem The government can decide to provide the public good if the total benefits exceed the costs. The government can make everyone better off by providing the public good and paying for it with tax revenue.

The Difficult Job of Cost-Benefit Analysis Cost benefit analysis refers to a study that compares the costs and benefits to society of providing a public good. In order to decide whether to provide a public good or not, the total benefits of all those who use the good must be compared to the costs of providing and maintaining the public good.

COMMON RESOURCES Common resources, like public goods, are not excludable. They are available free of charge to anyone who wishes to use them. Common resources are rival goods because one persons use of the common resource reduces other peoples use.

Tragedy of the Commons The Tragedy of the Commons is a parable that illustrates why common resources get used more than is desirable from the standpoint of society as a whole. Common resources tend to be used excessively when individuals are not charged for their usage.

Solution: Why Isnt the Cow Extinct?

Will the market protect me? Private Ownership and the Profit Motive!

CONCLUSION: THE IMPORTANCE OF PROPERTY RIGHTS The market fails to allocate resources efficiently when property rights are not well-established (i.e. some item of value does not have an owner with the legal authority to control it). When the absence of property rights causes a market failure, the government can potentially solve the problem.

Community Forest: Case of Property Rights in Nepal

Leftover/ Miscellaneous (Recommended to find more information on these)

Agency theory Theory describing conflicting relationship between principal and agents. Principal: employers Agent: employees Cause of conflict: difference of interests (self interests) due to delegation of authority Agency relationship: (1) between stockholders and managers and (2) between debtholders and stockholders. As an impact Agency relationship moral hazard problem may arise.

Behavioral Theory-Cyert and March Contrary to traditional microeconomic theories-firms take multiple of objectives due to various internal conflicting factors. Cyert and March: Various groups or coalitions exist within the organization as that shares a consensus on the goals Goals: production, stock, sales, market shares, profit and so on.

Oligopoly pricing models Price Leadership model Cartel kinked demand curve model

Price leadership model Assumes that in some market, there is one dominant firm in the industry that Determine the level of demand and sets the price Other firms in the industry behave like perfectly competitive price-taking firms Possible due to large amount of market share Price leader maintains the price such that the level of demand remains unreduced

Kinked demand-curve model Economic theory regarding monopolistic competitive and oligopoly market structures Assumes that the Oligopoly/ Monopolistic competitive market faces the kinked demand curved to maximize the profit.

Regular Oligopoly demand curve Quantity Costs and Revenue MR D MC Profit-maximizing output P Q

Decrease in MC? Quantity Costs and Revenue MR D MC New Profit-maximizing output New P Q MC

Kinked-Demand curve Quantity Costs and Revenue MR D MC New Profit-maximizing output New P Q MC

Pricing Method Cost plus pricing Method (adding up profit margin after calculating all costs) Incremental cost pricing (pricing based on variable cost, not on the basis of total cost) Multiple product pricing or Product line pricing (same MC but different MR) Transfer pricing (price charged by one department to other dept. of the same company for providing goods and services)

Economics with corporate decision makings and public policy design Decision making in Corporations involves: Demand analysis, production functions and costs, pricing decisions and policies, entry and exit strategies and so on.. Understanding of economics (managerial economics) provides strong foundations for such analyses Public policy design requires understandings various conditions such as efficiency, effects of taxes, externalities, international trade, elasticity and so on.

FYI-Forecasting Predicting demand for future based on available information Common forecast techniques: Qualitative analysis Expert opinion Survey Trend analysis and projection Economic data, growth, business cycle etc. Exponential smoothing (forecasting in unit-sales, growth, cost etc.) Econometrics method

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