CHAPTER 4 Public Goods Mc GrawHillIrwin Copyright 2008

Characteristics of Goods o o Excludable v Nonexcludable n Excludable – preventing anyone from consuming the good is relatively easy n Nonexcludable – preventing anyone from consuming the good is either very expensive or impossible Rival v Nonrival n Rival – once provided, the additional resource cost of another person consuming the good is positive n Nonrival – once provided, the additional resource cost of another person consuming the good is zero 4 -2

Types of Goods RIVAL YES EXCLUDABLE NO YES NO PRIVATE GOODS NATURAL MONOPOLY COMMON RESOURCES PUBLIC GOODS 4 -3

Noteworthy Aspects of Public Goods o o o 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 n 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 n publicly provided private goods Public provision of a good does not necessarily mean that it is also produced by the public sector 4 -4

Some Other Public Goods o Basic research o Programs to fight poverty o Uncongested nontoll roads o Fireworks display 4 -5

Efficient Provision of Private Goods Price $11 Adam (Df. A) 5 Eve (Df. A) 1 Market (Df. A+E) 6 $9 7 3 10 $7 9 5 14 $5 11 7 18 $3 13 9 22 $1 15 11 26 4 -6

$ Sf Df. A+E D f. A Quantity of Pizza 4 -7

Pareto Efficiency – Private Goods Case o o o o MRSfa = Pf/Pa Set Pa = $1 MRSfa = Pf Df. A shows MRSfa for Adam Df. E shows MRSfa for Eve Sf shows MRTfa Necessary condition for Pareto efficiency: MRSfa. Adam = MRSfa. Eve = MRTfa 4 -8

Efficient Provision of Public Goods Units of Fireworks 1 2 3 4 Adam (Dr. A) $300 $250 $200 $150 Eve (Df. E) Market (Df. A+E) 250 $550 200 $450 150 $350 100 $250 4 -9

$ Sr Dr. A+E Dr A Dr. E Quantity of Fireworks 4 -10

Pareto Efficiency – Public Goods Case o o o o MRSfa = Pf/Pa Set Pa = $1 MRSfa = Pf Df. A shows MRSfa for Adam Df. E shows MRSfa for Eve Sf shows MRTfa Necessary condition for Pareto efficiency: MRSfa. Adam + MRSfa. Eve = MRTfa 4 -11

Problems Achieving Efficiency o The Free-Rider Problem o Solutions to the free-rider problem n Perfect price discrimination o Policy Perspective: Global Positioning System o Do people free ride? 4 -12

Laboratory Experiments and Free-Riding o How a typical experiment works o Typical results o n People contribute about 50% of resources to provision of public good n Contributions fall the more often the game is repeated n Cooperation fostered by prior communication n Contribution rates decline when opportunity cost of giving goes up “Warm-glow” giving 4 -13

The Privatization Debate o Privatization – taking services supplied by government and turning them over to the private sector o Public v Private Provision: What is the right mix? n Relative wage and materials costs n Administrative costs n Diversity of tastes 4 -14

Distributional Issues o Commodity egalitarianism – notion that some commodities ought to be made available to everyone 4 -15

Public versus Private Production o o o o Efficiency of private production Problems in comparing cost differences Incomplete Contracts Competition to supply good or service Reputation building Policy Perspective: Should airport security be produced publicly or privately? Market Environment 4 -16

Preference Revelation Mechanisms o ∆TEve = MRTra – (MRSra. Total – MRSra. Eve) o Eve’s choice: ∆TEve = MRSra. Eve o By substitution: MRTra – (MRSra. Total – MRSra. Eve) = MRSra. Eve o Add (MRSra. Total – MRSra. Eve) to both sides: MRTra = MRSra. Total 4 -17