1 Public Goods and Common Resources Chapter 11

2 What do we learn in this chapter? • In Ch. 10 we applied the tools of welfare economics to externalities and evaluated private and public solutions to them • Externalities involve situations when the markets work but only inefficiently • However, for some social activities the market may fail altogether and simply can’t provide them • In other words, there is no price for these activities • Ch. 11 examines the case of those goods and services for which no market and therefore no price exists • Two new categories of goods introduced in Ch. 10 will be public goods and common resources

3 “The best things in life are free. . . ” • Most goods in our economy are allocated in markets • Where prices are the signals that guide the decisions of both buyers and sellers • When goods are available free of charge, the market forces that normally allocate resources in our economy are absent • When a good does not have a price attached to it, private markets cannot ensure that the good is produced and consumed in the proper amounts • In such cases, government moves in to raise economic well being • What kind of goods will have no price attached to them and why?

4 Different kinds of goods • We now develop a system of classification for all the goods and services produced in a modern market economy • To classify various goods, we use two concepts: excludability and rivalness • Excludability – Others can be prevented from enjoying the good – Laws recognize and enforce private property rights • Rivalness – One person’s use of the good reduces the benefits available to others

Four types of goods 5 • With two criteria we have four combinations of these criteria • Each category of goods will be either exclusable or not as well as rival or not • Private Goods – Are both excludable and rival • Public Goods – Are neither excludable nor rival • Common Resources – Are rival but not excludable • Natural Monopolies – Are excludable but not rival

6 Four types of goods Excludable?

How we proceed? 7 • In the previous chapters we studied different aspects of supply and demand always had established an equilibrium price • In other words we dealt with private goods that are both excludable and rival • In Part Five we will continue with private goods • Natural monopolies along with other types of monopolies will also be analysed in Part Five • Now we concentrate on the other two categories: public goods and common resources • We begin by defining public goods and problems related to them • Then move on to common resources

Public goods 8 • Goods that are not excludable and, therefore, are available to everyone free of charge are called public goods in opposition to private goods • In case of public goods obviously important externalities arise because something of value has no price attached to it • Everybody receive benefits from them without having to pay for the use of scarce resources that went into their production • Some important public goods are – National defense – Basic scientific research – Programs to fight poverty

The “free-rider” problem 9 • Public goods allow us to introduce a key concept of economics: free-riders • A free-rider is a person who receives the benefit of a good but avoids paying for it • Since people cannot be excluded from enjoying the benefits of a public good, individuals may withhold paying for the good hoping that others will pay for it • The free-rider problem prevents private markets from supplying public goods • It is in the interest of every individual to be a free rider, provided the rest of the society is not • When everybody become free-riders, the system collapses and the public good can’t be provided

10 Government and free-riders • When the free-rider problem prevents markets to supply a good, the government moves in • The government should provide the good if its total benefits exceed the costs • Government makes everyone better off by providing the good and paying for it with tax revenues • Hower, public provision of public goods can’t make the free-rider problem disappear only changes its dimensions • A small number of free-riders will evade taxes and manage to get the service without paying for it • Obviously, if everybody become free-rides, then there is no service (Turkey? )

Determining public foods 11 • Determining which goods are public goods is easy and simple in some cases because it is impossible to imagine otherwise • No market can exist for the army, the police, the justice system • But other cases can be very contraversial • Are lighthouses a public or private good? • Is education in general or university education a private or public good? • Why some roads are toll-roads and others are free? • These are difficult questions that are usually answered by politics and political ideologies in democratic societies

Cost-Benefit analysis 12 • Once it is decided that a public good is found, whether to provide it from the public purse requires the determination of its social benefits and social costs • A cost-benefit analysis has to be used to estimate the total costs and benefits of the project to the society • Cost-benefits analysis is easy theoretically but faces very important obstacles in practise • Without prices it becomes very difficult to calculate social benefits and resource costs for public goods • Many of the benefits and costs, such as the value of individual life or of the consumer’s time, and the value of aesthetics and beauty are very difficult to quantify, measure and assess

Common resources 13 • Goods that are rival as private goods but are not excludable like public goods are called common resources • Common resources are rival goods because one person’s use of the common resource reduces other people’s use • They are available free of charge to anyone who wishes to use them • Some examples of common resources – Clean air and water – Oil pools – Congested roads – Fish, whales, and other wildlife

Tragedy of commons 14 • The Tragedy of the Commons refers to the fact that a person’s use of a common resource diminishes other people’s enjoyment of it • This implies a non-optimal incentive system which leads to overuse of common resources • Every user tries to take most out before others • Overuse creates a negative externality • Government can impose a tax or regulate the use of the common resource or turn the common resource into a private good • Fishing in Marmara or Karadeniz is a good exemple • Every fisherman tries to get the maximum catch • But together they exhaust the fish in the sea

Importance of property rights 15 • Why does the market fails to allocate resources efficiently in the case of common resources? • The answer lies in property rights • It is the absence of property rights which cause market inefficiency for common resources • When the absence of property rights causes a market failure, the government can potentially solve the problem – by defining property rights and letting market forces work toward economic efficiency. – by regulating the private behavior that is causing overuse – or, if possible by supplying the good

Why the cow is not extinct? 16 • To see the importance economists attach to property rights we can look at an interesting example • That involves the touchy subjets of extinction • There are hundreds of millions of cows in the world and their number is increasing • Despite this the commercial value of a cow is bigger than that of most animals facing extinction • Only those animals who exist in the wilderness as a common resource are in danger • The key: cows are protected by private property • Which gives an incentive to its owners to make sure of their survival as a species • “Property rights” is an important concept

17 Conclusion • Markets may not exist at all for some goods or services that society needs • We can classify goods into four basic categories on two criteria: whether they are excludable and whether they are rival • Markets work best for private goods, which are both excludable and rival • Public goods are neither rival nor excludable • A free-rider get the benefits of a public good without paying the costs of providing it as long as others pay • The free-rider problem forces governments to provide public goods but tax evasion problem remains

Conclusion 18 • Common resources are rival but not excludable • Because people are not charged for their use of common resources, they have an incentive to use them excessively • Often resulting in the depletion of the common resource and everybody looses • Governments may try to reduce the use of common resources to socialll optimal levels through administrative regulation and market based taxation • An alternative is to define property rights better • Today the cow does not face extinction because it is protected by private property