1. McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. CHAPTER 4 Public Goods

2. 4-2 Public Goods  “There exists an intrinsic connection between the common good on the hand and the structure and the function of public authority on the other.”  “The moral order, which needs public authority in order to promote the common good in human society, requires also that the authority be effective in attaining that end.” Pope John XXIII

3. 4-3 Public Goods  Which goods and services should the public sector provide?  Which services that are currently provided by the government should be privatized?  These issues are in the heart of public policy and public finance.

4. 4-4 Goods  Army  Pizza  Education  Health  Etc…

5. 4-5 Public Goods  National Defense is an example of a pure public good, defined as fellows:  Once it is provided, the additional resource cost of another person consuming the good is zero – consumption is non-rival.  To prevent anyone from consuming the good is either very expensive or impossible – consumption is non-excludable.

6. 4-6 Private Goods  In contrast private good like pizza is rival and excludable.

7. 4-7 Characteristics of Goods  Excludable v 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 v 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.

8. 4-8 Types of Goods EXCLUDABLE RIVAL YESNO YES NO PRIVATE GOODS PUBLIC GOODS COMMON RESOURCES NATURAL MONOPOLY

9. 4-9 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 necessarily provided exclusively 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

10. 4-10 Some Other Public Goods  Basic research  Programs to fight poverty  Uncongested nontoll roads  Fireworks display

11. 4-11 Efficient Provision  Efficient provision of public good requires that the sum of individual MRS s equal the MRT, unlike the private goods where each MRS equals the MRT.  Market mechanisms are unlikely to provide non-rival goods efficiently, even if they are excludable.

12. 4-12 Horizontal and Vertical Summation  Horizontal Summation: Finding the market demand at an given price involves summing the horizontal distance between each of the private demand curves and the vertical axis at the price.  For a public good, the group willingness to pay is found by the vertical summation of the individual demand curve.

13. 4-13 Efficient Provision of Private Goods PriceAdam (D f A ) Demand for Fig Leave Eve (D f A ) Demand for Fig Leave Market (D f A+E ) Horizontal Summation $11516 $97310 $79514 $511718 $313922 $1151126

14. 4-14 DfADfA DfEDfE D f A+E SfSf $ Quantity of Pizza

15. 4-15 Pareto Efficiency – Private Goods Case  MRS fa = P f /P a  Set P a = $1  MRS fa = P f  D f A shows MRS fa for Adam  D f E shows MRS fa for Eve  S f shows MRT fa  Necessary condition for Pareto efficiency: MRS fa Adam = MRS fa Eve = MRT fa

16. 4-16 Efficient Provision of Public Goods Units of Fireworks 1234 Adam (D r A) $300$250$200$150 Eve (D f E ) 250 200 150 100 Market (D f A+E ) $550$450$350$250

17. 4-17 DrADrA Dr E D r A+E Sr Quantity of Fireworks $

18. 4-18 Pareto Efficiency – Public Goods Case  MRS fa = P f /P a  Set P a = $1  MRS fa = P f  D f A shows MRS fa for Adam  D f E shows MRS fa for Eve  S f shows MRT fa  Necessary condition for Pareto efficiency: MRS fa Adam + MRS fa Eve = MRT fa

19. 4-19 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? Compare US and Palestine.

20. 4-20 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

21. 4-21 The Privatization Debate  Public goods can be provided privately, and private goods can be provided publicly.  Even in cases where public provision of a good is selected, a choice between public and private production must be made.

22. 4-22 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

23. 4-23 Distributional Issues  Commodity egalitarianism – notion that some commodities ought to be made available to everyone.  Example: Provision of Medical Care in USA.  Example: Provision of Social Welfare in Palestine.

24. 4-24 Public versus Private Production  A key factor in determining whether public or private production depends on: 1. Efficiency of private production 2. Problems in comparing cost differences 3. Incomplete Contracts 4. Competition to supply good or service 5. Reputation building 6. Policy Perspective: Should airport security be produced publicly or privately? 7. Market Environment

25. 4-25 Education: Public or Private?  Discussion.