16 PUBLIC GOODS AND COMMON RESOURCES CHAPTER

Objectives After studying this chapter, you will able to Distinguish among private goods, public goods, and common resources. Explain how the free-rider problem arises and how the quantity of public goods is determined Explain the problem of the commons and its possible solutions

Free Riding and Overusing the Commons Why does government provide some goods and services such as the enforcement of law and order and national defense? Why don’t we let private firms produce these items and leave people to buy the quantities they demand? Ocean fish are a common resource that everyone is free to take. Are our fish stocks being depleted? What can be done to conserve the world’s fish?

Classifying Goods and Resources What is the essential difference between: A city police department and Brinks security Fish in the Atlantic Ocean and fish in a fish farm A live concert and a concert on television These, and all goods and services can be classified according to whether they are excludable or nonexcludable and rival or nonrival.

Classifying Goods and Resources Excludable A good, service, or resource is excludable if it is possible to prevent a person from enjoying its benefits. Nonexcludable A good, service, or resource is nonexcludable if it is impossible to prevent a person from enjoying its benefits.

Classifying Goods and Resources Examples of excludable items are: The services of Brinks security Fish in a fish farm A live concert Examples of nonexcludable items are: The services of the city police department Fish in the Atlantic Ocean A broadcast television signal

Classifying Goods and Resources Rival A good, service, or resource is rival if its consumption by one person decreases its consumption by other people. Nonrival A good, service, or resource is nonrival if its consumption by one person does not decrease its consumption by other people.

Classifying Goods and Resources Examples of rival items are: The services of Brinks security Fish both in ocean and in a fish farm A seat at a live concert Examples of nonrival items are: The protection provided by a city police department A broadcast television signal

Classifying Goods and Resources A Four-Fold Classification Private good A good or service that can be consumed by only one person at a time and only by those people who have bought it or own it. Public good A good or service that can be consumed simultaneously by everyone and from which no one can be excluded.

Classifying Goods and Resources Common resource A resource that is nonexcludable and rival—can be used only once but no one can be prevented from using what is available. Natural monopoly A good or service that is nonrival but excludable—can be produced at zero marginal cost.

Classifying Goods and Resources Figure 16.1 shows this four-fold classification of goods and services.

Public Goods and the Free Rider Problem A free rider is a person who consumes a good without paying for it. Public goods create a free-rider problem because the quantity of the good that a person is able to consume is not influenced by the amount that the person pays for the good, so no one has an incentive to pay and an unregulated market would produce an too little of the good.

Public Goods and the Free Rider Problem The Benefit of a Public Good The value of a private good is the maximum amount that a person would pay for one more unit, which is shown by the person’s demand curve. The value of a public good is the maximum amount that all the people are willing to pay for one more unit of it. The total benefit of a public good to an individual is the dollar value that a person places on a given level of provision of the good.

Public Goods and the Free Rider Problem The marginal benefit of a public good to an individual is the increase in total benefit that results from a one-unit increase in the quantity provided. The marginal benefit of a public good diminishes with the level of the good provided. Everyone can consume each unit of a public good, which means the marginal benefit for the economy is the sum of marginal benefits of each person at each quantity.

Public Goods and the Free Rider Problem Figure 16.2 shows how the marginal benefits of a public good are summed at each quantity of the good provided. Part (a) shows Lisa’s marginal benefit. Part (b) shows Max’s marginal benefit.

Public Goods and the Free Rider Problem The economy’s marginal benefit of a public good is the sum over the individuals at each quantity of the good provided. The economy’s marginal benefit curve for a public good is the vertical sum of each individual’s marginal benefit curve.

Public Goods and the Free Rider Problem It contrasts with the demand curve for a private good, which is the horizontal sum of the individual demand curves at each price.

Public Goods and the Free Rider Problem The Efficient Quantity of a Public Good The efficient quantity of a public good is the quantity that maximizes net benefit—total benefit minus total cost—which is the same as the quantity at which marginal benefit equals marginal cost. Figure 16.3 illustrates the efficient quantity.

Public Goods and the Free Rider Problem The total cost curve, TC, is like the total cost curve for a private good. The total benefit curve, TB, is just the sum of the marginal benefit at each output level. The efficient quantity is where net benefit is maximized.

Public Goods and the Free Rider Problem Equivalently, the efficient quantity is produced where marginal benefit equals marginal cost.

Public Goods and the Free Rider Problem The marginal benefit curve, MB, is the one we’ve just derived. The marginal cost curve, MC, is just like the MC curve for a private good. The efficient quantity is where marginal benefit equals marginal cost.

Public Goods and the Free Rider Problem Private Provision If a private firm tried to produces and sell a public good, almost no one would buy it. The free-rider problem results in too little of the good being produced.

Public Goods and the Free Rider Problem Public Provision Because the government can tax all the consumers of the public good and force everyone to pay for its provision, public provision overcomes the free-rider problem. If two political parties compete, each is driven to propose the efficient quantity of a public good. A party that proposes either too much or too little can be beaten by one that proposes the efficient amount, because more people vote for an increase in net benefit.

Public Goods and the Free Rider Problem The attempt by politicians to appeal to a majority of voters leads them to the same policies, which is an example of the principle of minimum differentiation—the tendency for competitors to make themselves identical to appeal to the maximum number of clients (voters). (The same principle applies to competing firms such as McDonald’s and Burger King).

Public Goods and the Free Rider Problem The Role of Bureaucrats Figure 16.4 shows the goal of the bureaucrat, which is to seek the highest attainable budget for providing a public good.

Public Goods and the Free Rider Problem Bureaucrats might provide the efficient quantity. But they try to increase their budget to equal the total benefit of the public good and drive the net benefit to zero. Bureaucrats might also try to over provide a public good.

Public Goods and the Free Rider Problem Well-informed voters would ensure that the politicians prevented the bureaucrats from increasing their budget above the minimum total cost of producing the efficient quantity. But is it not rational for voters to be well informed.

Public Goods and the Free Rider Problem Rational Ignorance Rational ignorance is the decision by a voter not to acquire information about a policy or public goods provision because the expected benefit to the voter from knowing the information is less than the cost of acquiring the information.

Public Goods and the Free Rider Problem For voters who consume but don’t produce a public good, it is rational to be ignorant about the costs and benefit. For voters who produce a public good, it is rational to be well informed. So the political equilibrium is one that favors the producer and bureaucrat and is an inefficient over provision of public goods.

Public Goods and the Free Rider Problem Two Types of Political Equilibrium The two types of political equilibrium—efficient provision and inefficient over provision of public goods correspond to two theories of government: Social interest theory predicts that political equilibrium achieves efficiency because well-informed voters refuse to support inefficient policies. Public choice theory predicts that government delivers an inefficient allocation of resources—that government failure parallels market failure.

Public Goods and the Free Rider Problem Why Government Is Large and Grows Government grows because the demand for some public goods is income elastic. Government might be too large because of inefficient overprovision.

Public Goods and the Free Rider Problem Voters Strike Back If government grows to large relative to the value voters place on public goods, there might be a voter backlash that leads politicians to propose smaller government. Privatization is one way of coping with overgrown government and is based on distinguishing between public provision and public production of public goods.

Common Resources The Problem of the Commons The problem of the commons is the absence of incentives to prevent the overuse and depletion of a commonly owned resource. Examples include the Atlantic Ocean cod stocks, South Pacific whales, and the quality of the earth’s atmosphere. The traditional example from which the term derives is the common grazing land surrounding middle-age villages.

Common Resources Sustainable Production Figure 16.5 illustrates production possibilities from a common resource. As the number of fishing boats increases, the quantity of fish caught increases to some maximum. Beyond that maximum, the sustainable catch decreases.

Common Resources An Overfishing Equilibrium Figure 16.6 shows why a common resource get overused. 1. The average catch per boat, which is the marginal private benefit, MPB, decreases as the number of boats increases. 2. The marginal cost per boat is MC (assumed constant).

Common Resources 3. Equilibrium occurs where marginal private benefit, MPB, equals marginal cost, MC. In equilibrium, the resource is overused because no one takes into account the effects of her/his actions on other users of the resources.

Common Resources The Efficient Use of the Commons The quantity of fish caught by each boat decreases as the number of boats increases. But no one has an incentive to take this fact into account when deciding whether to fish. The efficient use of a common resource requires marginal cost to equal marginal social benefit.

Common Resources Marginal social benefit is the increase in total fish catch that results from an additional boat, not the average catch per boat. The table on the next slide shows the calculation of marginal social benefit.

Common Resources Boats Total Catch MSB A 90 B 1 70 C 2 160 50 D 3 210 90 B 1 70 C 2 160 50 D 3 210 30 E 4 240

Common Resources Figure 16.7 illustrates the efficient use of a common resource. 1. The marginal social benefit curve, MSB, is below the MPB curve. 2. The resource is used efficiently when MSB equals MC.

Common Resources Achieving an Efficient Outcome It is harder to achieve an efficient use of a common resource than to define the conditions under which it occurs. Three methods in use are: Property rights Quotas Individual transferable quotas (ITQs)

Common Resources Property Rights By assigning property rights, common property becomes private property. When someone owns a resource, the owner is confronted with the full consequences of her/his actions in using that resources. The social benefits become the private benefits.

Common Resources In Figure 16.7, the marginal social benefit curve, MSB, becomes the marginal private benefit curve. The resource is used efficiently because the owner of the resources is best off when MSB equals MC.

Common Resources Quotas By assigning setting a production quota at the efficient quantity, a common resource might remain in common use but be used efficiently. Figure 16.8 shows this situation. It is hard to make a quota work.

Common Resources Individual Transferable Quotas An individual transferable quota (ITQ) is a production limit that is assigned to an individual who is free to transfer the quota to someone else. A market emerges in ITQs. If the efficient quantity of ITQs is assigned, the market price of a quota confronts resource users with a marginal cost that equals MSB at the efficient quantity.

Common Resources Figure 16.9 shows the situation with an efficient number of ITQs. Marginal cost rises from MC0 to MC1. Users of the resource make marginal private benefit, MPB, equal to marginal private cost, MC1, and the outcome is efficient.

Common Resources Public Choice and Political Equilibrium It is easy for economists to agree that ITQs make it possible to achieve an efficient use of a common resource. It is difficult to get the political market place to deliver that outcome. In 1996, Congress killed an attempt to use ITQs in the Gulf of Mexico and the Northern Pacific Ocean. Self-interest and capture of the political process sometimes beats the social interest.

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