1. Economics 10 1 2017 September Lecture 10 Chapter 17 Public Goods
2017 Economics 101 CCC

2. Content
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 tragedy of the commons and its possible solutions

3. Classification of goods

4. Classifying Goods and Resources
Goods, services and resources differ in the extent to which people can be
excluded from consuming them
extent to which one person’s consumption rival other people’s consumption.
Goods, services, and resources can be classified according to whether they are
excludable or non-excludable
and
rival or non-rival.

5. Classifying Goods and Resources
Excludable
A good is excludable if only the people who pay for it are able to enjoy its benefits.
Ex: Brink’s security services, Aquaculture’s Farm fish, and a Coldplay concert.
Non-Excludable
A good is non-excludable if it is impossible (or extremely costly) to prevent anyone from benefiting from it.
Ex police, fish in the Pacific Ocean, and a concert on network television

6. Classifying Goods and Resources
Rival
A good is rival if one person’s use of it decreases the quantity available for someone else.
Ex: Brink’s truck can’t deliver cash to two banks at the same time. A fish can be consumed only once.
Non-Rival
A good is non-rival if one person’s use of it does not decrease the quantity available for someone else.
Ex: services of the police keep us safer and a concert on network television are non-rival.

7. Classifying Goods and Resources
A Four-Fold Classification
Private Goods
A private good is both rival and excludable.
A bottle of Coke and a fish on Aquaculture’s Farm
Public goods
A public good is both non-rival and non- excludable.
A public good can be consumed simultaneously by everyone, and no one can be excluded from its benefits.
National defense.

8. Classifying Goods and Resources
Common Resources
A common resource is rival and non-excludable.
A unit of a common resource can be used only once, but no one can be prevented from using what is available.
common - Ocean fish
rival - fish taken by one person isn’t available for anyone else.
non excludable - difficult to prevent people from catching them.

9. Classifying Goods and Resources
Natural Monopoly Goods
Natural monopoly – result of industry where there are high fixed costs of distribution, such as exist when large-scale infrastructure is required to ensure supply.
Ex: cell phone firms
natural monopoly good is non-rival and excludable.
Ex: special case of natural monopoly arises when the good or service can be produced at zero marginal cost. (wireless charge!|)
Such a good is non-rival. If it is also excludable, it is produced by a natural monopoly.
Ex: Internet and cable television.

10. Classifying Goods and Resources
four-fold classification of goods and services.

11. Public Goods

12. Public Goods Defined Pure public goods share two characteristics
non-rival – Cost of another person consuming the good is zero
non-excludable – Very expensive to prevent others from consuming the good

13. Examples of public and private goods
Public Goods
National defense
House cleaning in an apartment with many roommates
Fireworks display
Music file sharing
Uncongested freeway
Private goods
Pizza
Health care
Congested freeway
Public housing

14. Valuation of public goods
Everyone consumes same quantity of public good
Marginal benefit of public good varies by person
In the housecleaning example, different roommates value the clean apartment differently.

15. Impure public goods
Most goods that are thought of as public goods may not strictly satisfy the non-rival or non-excludable assumption.
A scenic view is a public good without congestion, but the quality diminishes as more the number of sightseers increases.
Thus, a scenic view becomes rival.

16. Public Goods Why does the government provide weather forecasting?
Environment Canada!
Why don’t we buy it in the marketplace, as we buy hamburgers?
The answer is: Weather forecasting is a public good and has a free-rider problem.

17. Public Goods The Free-Rider Problem
A free rider enjoys the benefits of a good or service without paying for it.
Because no one can be excluded from the benefits of a public good, everyone has an incentive to free ride.
Public goods create a free-rider problem.
A free-rider problem is that the market would provide an inefficient quantity of the public good.
Marginal social benefit from a public good would exceed its marginal social cost and a deadweight loss would be created.

18. Public Goods Marginal Social Benefit of a Public Good
Public goods have a marginal social benefit that differs from the marginal social benefit for a private good.
Because everyone can consume services from the same unit of a public good, the marginal social benefit of a public good is the maximum amount that all the people are willing to pay for one more unit. The economy’s marginal social benefit curve for a public good is obtained by vertically summing each individual’s marginal benefit curve.
Efficient Quantity of a Public Good
The efficient quantity of a public good is the quantity that sets the marginal social benefit equal to the marginal social cost. At this quantity, society’s net benefit from the public good is maximized.

19. Public goods What is “vertical” vs. “horizontal” summation
Private goods, we want to know how many units should be produced to satisfy market demand at a given price.
private goods are both rival and excludable, each buyer must have his or her own units, so we must add together the number of units demanded by each individual.
horizontal coordinates (quantities) of individual demand curves to get the market demand curve
Public Goods, we are adding the individual demand curves or marginal benefit curves “horizontally.”
public goods are nonrival and nonexcludable, anyone who purchases a good is providing that good to everyone. If every consumer in the market demands one unit of a good, we can’t simply add together all of those units. Once one unit is provided to anyone, it is provided to everyone.
benefit of that unit will be determined by the sum of individual marginal benefits for that unit and individual’s marginal benefit is measured as the y coordinate of an individual demand curve, so to find the marginal social benefit, we add all of the individual marginal benefits together. We say we are adding the individual demand curves or marginal benefit curves “vertically”.

20. Public Goods
The economy’s marginal social benefit of a public good is the sum of the marginal benefits of all individuals at each quantity of the good provided.
The economy’s marginal social benefit curve for a public good is the vertical sum of all individual marginal benefit curves.

21. Consider a fireworks display as a public good – it is non-rival and non- excludable.
Bigger displays give higher benefit.
Public good: holding Q constant, add together individual willingness-to- pay to get P.
Vertical summation.

22. Everyone consumes the same quantity, Q
Individual’s marginal benefit varies.
Efficiency requires that the sum of individual marginal benefits equals the marginal cost.

23. Public Goods The Marginal Social Cost of a Public Good
The marginal social cost of a public good is determined in the same way as that of a private good.
The Efficient Quantity of a Public Good
The efficient quantity of a public good is the quantity that at which marginal social benefit equals marginal social cost.

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

25. Public Goods Solutions to the free rider problem
Efficient 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.
Solutions to the free rider problem

26. Privatization debate
Privatization means taking services that are supplied by the government and turning them over to the private sector for provision and/or production.
Examples with competing public/private provision include policing, parks, and even the judicial system.

27. Private production
Even if there is agreement that the public sector should provide a good, it is not clear whether the public sector should produce it.
Airport security workers are a timely example.
Public sector managers may not have a strong incentive to control costs because of the lack of profit motive or fears of takeovers or bankruptcy.
Quality of public services may be higher, however. This is more relevant when contracts are incomplete.
Consider Public goods – education? Health care?

28. Tragedy of the commons

29. Tragedy of the Commons
tragedy of the commons is the absence of incentives to prevent the overuse and depletion of a commonly owned resource.

30. Tragedy of the Commons Unsustainable Use of a Common Resource
Many common resources are renewable—they replenish themselves by the birth and growth of new members of the population.
A common resource is being used unsustainably if its rate of use persistently decreases its stock.
A common resource is being used sustainably if its rate of use is less than or equal to its rate of renewal so that the stock either grows or remains constant.
individual benefits while the group pays for the use, extraction and consequences.

31. Tragedy of the Commons Examples
overuse basis public good being rival but non-excludable
Overuse of parks
Smog in cities – too many people driving or driving too much
Congestion on the web – using up too much bandwidth
Highways

32. Common Resources: Sustainable Curve
Unsustainable Use of a Common Resource
Many common resources are renewable—they replenish themselves by the birth and growth of new members of the population.
A common resource is being used unsustainably if its rate of use persistently decreases its stock.
A common resource is being used sustainably if its rate of use is less than or equal to its rate of renewal so that the stock either grows or remains constant.

33. Common Resources: Sustainable Curve
As the stock of fish increases, the sustainable catch increases to a maximum.
As the stock increases further, the fish must compete for food and the sustainable catch falls.

34. Common Resources: Sustainable Curve
If the catch is less than the sustainable catch at a given stock, such as point Z, the fish stock grows.
If the catch exceeds the sustainable catch at a given stock, such as point A, the fish stock shrinks.
The SCC shows the sustainable catch and an unsustainable catch for a given stock that keeps the stock unchanged.

35. Common Resources: MB & MC (private and social)
The Overuse of a Common Resource
Why does overfishing occurs?
The supply curve is the marginal private cost curve, MC.
The demand curve is the marginal social benefit curve, MSB.
Market equilibrium occurs at 800,000 tonnes per year and $10 a kilogram.
Private

36. Common Resources: MB & MC (private and social)
Private & External Cost – Social Cost
The Overuse of a Common Resource
Why does overfishing occurs?
The marginal social cost curve is MSC.
The efficient quantity is 300,000 tonnes per year.
At the market equilibrium, there is overfishing and a deadweight loss arises.

37. Common Resources & Efficiency
conditions under which a common resource is used efficiently.
A common resource is used efficiently when the marginal social benefit equals the marginal social cost at the quantity produced.

38. Common Resources & Efficiency
Achieving an Efficient Outcome Tragedy of Commons
The three main methods used to achieve the efficient use of a common resource are
Property rights
Production quotas
Individual transferable quotas (ITQs).

39. Common Resources & Efficiency
Three methods to move toward efficiency:
1. Property Rights By assigning property rights to what was previously a common resource, its owner faces the same condition as society faces
The users of the resource will be confronted with the full cost of using it because they either own it or pay a fee to the owner for permission to use it.
Assigning property rights is not always feasible. It would be difficult to assign private property rights to the oceans.

40. Common Resources & Efficiency
Three methods to move toward efficiency:
2. Production Quotas A production quota is an upper limit to the quantity of a good that may be produced in a specified period.
The quota is allocated to individual producers, so each producer has its own quota.
Problem: best interest of every producer to cheat on the quota, because price exceeds marginal private cost.

41. Common Resources & Efficiency
Three methods to move toward efficiency:
3. Individual Transferable Quotas (ITQ) An ITQ is a production limit that is assigned to an individual who is then free to transfer (sell) the quota to someone else.
A market in ITQs emerges and ITQs are traded at their market price, which is the highest price that someone is willing to pay for one.
At the efficient quantity, the marginal cost, which now includes the opportunity cost of the ITQ, equals the marginal social benefit. So no one has an incentive to exceed the quota because to do so would send marginal cost above price and result in a loss on the marginal catch.
outcome is efficient.

42. Solutions to the Tragedy of the Commons
Why do we need these?
Hardin argues against the reliance on conscience as a means of policing commons. Morals and conscience would favour selfish individuals over those more far- sighted (i.e., people act for own self-interest).

43. Solutions to the Tragedy of the Commons
Property Rights
By converting the common resource to private property, fishers face the full social cost of their actions.
The marginal social cost curve becomes the supply curve and the resource is used efficiently.

44. Solutions to the Tragedy of the Commons
Production Quotas
By setting a production quota at the efficient quantity, the resource might be used efficiently.
Figure 17.9 shows the profit on the marginal tonne of fish.
A fisher who cheats will increase his profit. There is an incentive to overfish.

45. Solutions to the Tragedy of the Commons
Individual Transferable Quotas
An individual transferable quota (ITQ) is a production limit that is assigned to an individual who is free to transfer (sell) the quota to someone else.
A market in ITQs emerges.
If the efficient quantity of ITQs is assigned, the market price of an ITQ confronts resource users with a marginal cost equal to MC + price of ITQ.
With MC + price of ITQ equal to MSB, the quantity produced is efficient.

46. Solutions to the Tragedy of the Commons
Individual Transferable Quotas
efficient number of ITQs.
The market price of an ITQ increases the marginal social cost to MC + price of ITQ.
Users of the resource make MSB equal MC + price of ITQ, and the outcome is efficient.

47. Toll Highways
Toll on Highways
The Tragedy of the Commons is often used proponents of free trade and market-based strategies.
The example is a toll-road (ETR407) versus a government- maintained road (Highway 401). The 401 is congested, while ERT407 has less traffic.
If roads were privately owned, owners would charge tolls and people would take the toll into account in deciding whether to use them. Owners of private roads would engage in peak-load pricing (i.e., charging higher prices during times of peak demand and lower prices at other times).
When governments own roads financed with tax dollars, tolls are not normally charged. The government makes roads into a commons. The result is congestion.

48. Cap & Trade: Emissions Trading Systems
Also known as cap and trade – market-based
In order to pollute a specific amount (say 10 tons), companies have to hold that number of allowances, or credits (10 tons of credits).
An overall regional cap is placed on the number of allowances, to ensure good air quality. Cap can be lowered over time to improve air quality.
Companies that need to increase their emission allowances must buy credits from those who pollute less.
The transfer of allowances is referred to as a trade.

49. Cap & Trade: Emissions Trading Systems
Examples:
U.S. national cap-and-trade system for sulfur dioxide, established under the Acid Rain Program of the 1990 Clean Air Act (first cap-and-trade system in the U.S.)
Texas banking & trading system for precursors that form the air pollutant ground-level ozone (nitrogen oxides and volatile organic compounds)
Baseline and credit program – each company has a regulatory limit. Companies can bank and sell credits if they reduce pollution below their regulatory limit.
European Union trading scheme for greenhouse gases

50. Triple Bottom Line
Triple bottom line accounting: expanding the traditional reporting framework to take into account ecological and social performance in addition to financial performance
Company’s responsibility is to stakeholders, not only shareholders. Requires a corporate commitment to social responsibility.
Who would stakeholders be?
3 Ps of the triple bottom line:
Planet
Profit
People
Stakeholders:
People living around the manufacturing plant or industrial facility (Are they exposed to pollution from the plant?)
Workers in the plant (Are safety regulations enforced? Are they treated equitably?)
Local community
Shareholders
Others

51. questions
How and why do both public goods and common resources have the potential to create inefficiency?
Government policies might provide the efficient quantity of a public good and might overcome the tragedy of the commons. T or F? Explain
What exactly is the tragedy of the commons?
Contrast the different type of public goods.
What is a free rider and how does it apply to pubic goods?
Distinguish among public goods, private goods, common resources, and natural monopoly goods. Examples?

52. questions
What is the free-rider problem? Why do free riders make the private provision of a public good inefficient?
What is the tragedy of the commons? Give two examples, including one from your province.
How can you make tragedy of the commons more efficient? Three methods?

53. End of slides