Chapter 4 Public Goods 1 Public Goods n

Chapter 4 Public Goods 1

Public Goods n Public Goods are goods for which exclusion is impossible. n One example is National Defense: A military that defends one citizen from invasion does so for the entire public. 2

Characteristics of Public Goods n Nonexclusion: The inability of a seller to prevent people from consuming a good if they do not pay for it. n Nonrivalry: The characteristic that if one person “consumes” a good, another person’s pleasure is not diminished, nor is another person prevented from consuming it. 3

Pure Public Goods and Pure Private Goods n n Pure Public Good: No ability to exclude and no rivalry for benefits. Pure Private Good: Clear ability to exclude and rivalry for benefits. 4

Marginal Costs for Provision of Public Goods n The marginal cost of allowing another person to benefit from a pure public good is zero, while the marginal cost of providing a greater level of public good is positive. 5

Figure 4. 1 Marginal Costs of Consuming and Producing a Pure Public Good-Figure A Cost (Dollars) 200 Marginal Cost of Allowing an Additional Person to Consume a Given Quantity of Pure Public Good 0 1 Number of Consumers 6

Figure 4. 1 Marginal Costs of Consuming and Producing a Pure Public Good--Figure B Marginal Cost of Producing a Pure Public Good MC = AC Cost (Dollars) 200 0 Units of a Pure Public Good per Year 7

Example: Bread versus Heat n Bread – Clearly a pure private good because there is the ability to exclude and there is rivalry to consume. n Heat – Clearly a pure public good because there is no ability to exclude and there is no rivalry to consume. 8

Provision of Private Good and Public Goods: Markets and Government §Price Excludable Public Goods vs §Congestible Public Goods 9

Price Excludable Public Goods Excludability, but no rivalry n Another type of good is a priceexcludable public good: no rivalry but exclusion is easy. Examples: Country Clubs, Cable TV 10

Congestible Public Goods Rivalry but no excludability n There are public goods where, after a point, the enjoyment received by the consumer is diminished by crowding or congestion. These are called Congestible Public Goods. n Examples: roads and parks 11

Marginal Cost Figure 4. 2 A Congestible Public Good Marginal Cost per User 0 1 Number of Consumers per Hour 12

Figure 4. 3 Classifying Goods According to the Degree of Rivalry and Excludability of Benefits from Their Use 1 A C Excludability H B 0 Rivalry 1 13

Education as a Public Good n n Education is a service that has some characteristics of a public good and some characteristics of a private good. External benefits n n n It helps us live in a civil society. It has a “socializing ” function. It teaches the importance of following rules, obeying orders, and working together. It provides students with basic skills like punctuality and the ability to follow directions that increase their productivity as workers. It helps students identify their abilities and choose appropriate occupations, thereby increasing productivity levels for a nation. 14

Education as a Private Good n Education has characteristics of a private good. n n n Wide disparities exist in the quantity and quality of education provided among school districts. The level of support that parents can give students at home increases with income and home support is an important factor in learning for children. There is no way to prevent parents who want more than a standardized quantity and quality of education for their children from buying it in the marketplace. 15

Demand For a Pure Public Good n n Market demand for a Pure Private Good is derived by adding quantities demanded at each price. Demand for a Pure Public Good is derived by adding how much people will be willing to pay at each quantity. 16

Price per Loaf of Bread (Dollars) Figure 4. 4 Demand For a Private Good 7 6 5 4 E 3 S = MC = AC D = QD DC = MBC DB = MBA DA = MBA 2 1 0 1 2 3 4 5 6 7 8 9 Loaves of Bread Purchased per Week 10 17

Marginal Benefit (Dollars) Figure 4. 5 Demand For A Pure Public Good 800 700 600 500 400 300 200 100 0 Z 1 Z 2 Z 3 Z 4 D= MBA DA = MBA DB = MBB DC = MBC 1 2 3 4 5 Security Guards per Week 18

Marginal Benefit (Dollars) Figure 4. 6 Efficient Output for a Pure Public Good 800 700 600 500 E MC = AC = MSB 400 300 200 100 0 D= MBi = MSB MBA MBB MBC 1 2 3 4 5 Security Guards per Week 19

Efficient Output of a Pure Public Good n The socially optimal level of the public good requires that we set the Marginal Social Benefit of that good equal to its Marginal Social Cost. MSB = MSC § n Lindahl Pricing: Everyone in a group cooperates and participants each pay their marginal benefit. n We can demonstrate this issue mathematically, numerically (using a table), and graphically. 20

Mathematically: Lindahl Pricing Recall from Figure 4. 5 that the marginal social benefit for a pure public good is the sum of the individual marginal benefits. That is: MSB = MB. Efficient output is therefore: MSB = MSC. 21

Numerically: Lindahl Pricing n Suppose we have three people who are discussing the issue of hiring security guards. Note that each person places a different value on the levels of security. 22

A Numerical Example Number of Security Guards per Week 1 2 3 4 MBA $300 $250 $200 $150 MBB $250 $200 $150 $100 MBC $200 $150 $100 $50 MB $750 $600 $450 $300 If the cost of security guards is $450 per week, then no individual will hire even one guard, even though to the group one guard is worth $750. The group should hire three. If they each pay their marginal benefit, then three guards are hired. Person A pays $600 ($200 per guard), person B pays $450 ($150 per guard) and person C pay $300 ($100 per guard). 23

Lindahl Equilibrium n n The amount each person contributes, ti, depends on individual desires for the public good. The sum of the contributions equals the total cost of the public good. n n n ti. Q* = MC(Q*) = AC(Q*) ti = MC = AC All individuals agree to pay their shares. 24

Freeriding n Freeriding occurs when people are not honest in stating their Marginal Benefit, because if they understate it, they can get a slightly reduced level of the public good while paying nothing for it. 25

Freeriding is easier with n Anonymity: If everyone knows who contributes, there can be powerful social stigmas applied to shirkers. n Large numbers of people: It’s easier to determine the shirkers in a small group and the punishment is more profound when people close to you shun you for not paying your share. 26

Illustrating Voluntary Contributions to a Public Good: The Gulf War n n n Under the premise that defeating Iraq in the Gulf War in 1990 was a public good to be consumed by the industrialized economies and Arab nations, each nation was expected to contribute. The U. S. and UK contributed the bulk of the fighting forces. Saudi Arabia, Kuwait, the UAE, Japan, and Germany voluntarily paid $54 billion of the estimated $61 billion cost. 27

National Defense and Homeland Security n National defense is a classic example of a public good. n Defense n n n From 1968 to 1978, defense spending fell from 9% of GDP to 5%. Between 1978 and 1986, it increased to 6. 3%. By 1999, it had fallen to less than 4%. In 2002, it was 4. 5%. Homeland Security n The new department merged several agencies from the departments of Justice, Transportation, Treasury, Agriculture, Energy, Health and Human Services, and Commerce. n The Homeland Security Department could ultimately have 170, 000 employees working in border and transportation security, emergency preparedness and response, biological warfare defense, and computer security. It will also house the Secret Service and Coast Guard. 28