Public Goods. Public Goods -- Definition u Public goods involve a particular kind of externality - where the same amount of the good has to be available.

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Presentation transcript:

Public Goods

Public Goods -- Definition u Public goods involve a particular kind of externality - where the same amount of the good has to be available to everyone. u The same amount must be provided to all. u But people can value the public good in different ways.

Public Goods -- Definition u A good is public if it is both nonexcludable and nonrival in consumption. –Nonexcludable -- all consumers can consume the good. –Nonrival -- each consumer can consume all of the good.

Public Goods -- Examples u National defense. u Public highways. u Street lights. u Reductions in air pollution. u National parks. u (Broadcast radio and TV programs.)

Public Goods u Two questions about public goods 1. what is the optimal amount of a public good? 2. how well do various social institutions work in providing the optimal amount of a public good?

Reservation Prices u A consumer’s reservation price for a unit of a good is his maximum willingness-to-pay for it. u Consumer’s wealth is u Utility of not having the good is

Reservation Prices u A consumer’s reservation price for a unit of a good is his maximum willingness-to-pay for it. u Consumer’s wealth is u Utility of not having the good is u Utility of paying p for the good is

Reservation Prices u A consumer’s reservation price for a unit of a good is his maximum willingness-to-pay for it. u Consumer’s wealth is u Utility of not having the good is u Utility of paying p for the good is u Reservation price r is defined by

When Should a Public Good Be Provided? u One unit of the good costs c. u Two consumers, A and B. u is sufficient for it to be efficient to supply the good.

Private Provision of a Public Good? u Suppose and. u Then A would supply the good even if B made no contribution. u B then enjoys the good for free; free- riding.

Private Provision of a Public Good? u Suppose and. u Then neither A nor B will supply the good alone.

Private Provision of a Public Good? u Suppose and. u Then neither A nor B will supply the good alone. u Yet, if also, then it is Pareto- improving for the good to be supplied.

Private Provision of a Public Good? u Suppose and. u Then neither A nor B will supply the good alone. u Yet, if also, then it is Pareto- improving for the good to be supplied. u A and B may try to free-ride on each other, causing no good to be supplied.

Solutions u Public provision of the good (collect taxes to finance it). u Private subsidized provision of the good. u Before: make a cost-benefit analysis to decide whether the good should be provided or not.

Solutions u Other private solutions: –development of new means to exclude nonpayers –donations –clubs –sell a by-product.