Chapter
11
Public Goods and Common
Resources
The Different Kinds of Goods
• Two criteria for classifying different kinds of
goods
1. Excludability
• Can a person can be prevented from using it?
– Yes – Private Good (PMB=SMB, no externality)
– No – Public Good or Common Property/Resource
» Externality (either SMB > PMB or PMC < SMC)
2. Rivalry in consumption
• Does one person’s use diminishes other people’s use?
– Yes – Private Good
– No – Public Good or Common Property
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Figure 1
Four types of goods
Rival in consumption?
Yes
Yes
Excludable?
No
No
Private goods
Natural monopolies
- Ice-cream cones
- Clothing
- Congested toll roads
- Fire protection
- Cable TV
- Uncongested toll roads
Common resources
Public goods
- Fish in the ocean
- The environment
- Congested nontoll roads
- Tornado system
- National defense
- Uncongested nontoll roads
Goods can be grouped into four categories according to two characteristics:
(1) A good is excludable if people can be prevented from using it.
(2) A good is rival in consumption if one person’s use of the good diminishes other
people’s use of it.
This diagram gives examples of goods in each category.
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The Different Kinds of Goods
• Types of goods
– Public goods
• Not excludable & Not rival in consumption
– Common resources
• Rival in consumption & Not excludable
– Private goods
• Excludable & Rival in consumption
– Natural monopoly
• Excludable & Not rival in consumption
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The Different Kinds of Goods
• Public goods & Common resources
– Not excludable: people cannot be prevented
from using them (free riders)
– Externalities
• Public Good: positive externality/benefits for the
public, but not compensated for in market
– SMB > PMB -> 2 different demand curves
» Produce too little when PMB = PMC (Market)
• Common property resource: negative
externality/costs
– PMC < SMC -> 2 different cost curves
» Overuse of the resource
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Public Goods
• The free-rider problem (can’t exclude)
Free rider = not excludable
• Person who receives the benefit of a good but avoids
paying for it
1. Public goods = can’t get everyone to pay for
benefits derived (e.g., fire protection)
• Free-rider prevents the private market from supplying the
economically efficient as SMB > PMB but people only pay
for PMB
2. Common Property
• Others use of the property degrades productivity ->
imposing costs on others (SMC > PMC)
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Public Goods
• The free-rider problem
– Government - can remedy the problem
• If total benefits > costs of a public good, then:
1. Provide the public good (or subsidize it)
2. Pay for it with tax revenue
– Makes everyone better off
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Public Goods
• Some important public goods
– National defense
• Very expensive public good
– Basic research
• General knowledge
– Fighting poverty
• Welfare system
• Food stamps
– Education
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Are lighthouses public goods?
• Lighthouses (an older example)
– Mark specific locations so that passing ships can
avoid treacherous waters
• Benefit - to the ship captain
– Not excludable, not rival in consumption
• Incentive – free ride without paying
– Most - operated by the government
• In some cases
– Lighthouses - closer to private goods
• Coast of England, 19th century
– Lighthouses – privately owned and operated
– The owner - charged the owner of the nearby port
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Are lighthouses public goods?
• Decide whether something is a public good
– Determine who the beneficiaries are
– Determine whether the beneficiaries can be
excluded from using the good
• A free-rider problem
– When the number of beneficiaries is large
– Exclusion of any one of them is impossible
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Public Goods
• The difficult job of cost–benefit analysis
– Government
• Decide what public goods to provide
• In what quantities
– Cost–benefit analysis
• Compare the costs and benefits to society of
providing a public good
• Don’t have any price signals to observe
– See Harris
• Government findings on the costs and benefits
– Rough approximations at best
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How much is a life worth?
• Cost: $10,000 – new traffic light
• Benefit: increased safety
– Risk of a fatal traffic accident
• Drops from 1.6% to 1.1 %
• Obstacle
– Measure costs and benefits in the same units
• Put a dollar value on a human life
– Priceless = infinite dollar value
– Expected future earnings
• Underestimates – “non-pecuniary” ($) benefits
• Lower bound (or minimum value)
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How much is a life worth?
• Put a dollar value on a human life
– Implicit dollar value
• Courts - award damages in wrongful-death suits
– Ignores other opportunity costs of losing one’s life
• Occupational Risks - people are voluntarily willing to take
– Value of human life = $10 million
• Cost-benefit analysis
• Traffic light
– Reduces risk of fatality by 0.5 percentage points
• Expected benefit = 0.005 × $10 million = $50,000
• Cost ($10,000) < Benefit ($50,000)
• Approve the traffic light
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Common Resources
• Common resources
– Not excludable
– Rival in consumption
• The tragedy of the commons
– why are common resources used more than is
desirable
• Social and private incentives differ
• Arises because of a negative externality
– Don’t take into account costs imposed on others
when equating PMB and PMC
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Common Resources
• The tragedy of the commons
– Negative externality
• One person uses a common resource
– Diminishes other people’s enjoyment of it
• Common resources tend to be”overused”
– Government - can solve the problem
• Regulation or taxes
– Reduce consumption of the common resource
• Turn the common resource into a private good
– Tradable permits (Individually Transferable Quotas)
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Common Resources
• Some important common resources
– Clean air and water
– Congested roads
– Fish, whales, and other wildlife
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Property Rights
• Externalities often arise because of a lack
of clearly defined property rights.
– Ask: Who owns the air? Can I pollute?
• Private property
– Provides exclusive right of ownership that
allows for the use and exchange of property
– Creates incentive to maintain, protect, and
conserve property, as well as listen to the
wishes of others
Private Solutions to Externalities
• The Coase theorem
– If private parties can bargain without cost
over the allocation of resources
• They can solve the problem of externalities on
their own
– Private economic actors
• Can solve the problem of externalities among
themselves
– Whatever the initial distribution of rights
• Interested parties - reach a bargain:
– Everyone is better off & Outcome is efficient
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Private Solutions to Externalities
• Why private solutions do not always work
– High transaction costs
• Costs that parties incur in the process of agreeing
to and following through on a bargain
– Bargaining simply breaks down
– Large number of interested parties
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Why the cow is not extinct
• Species of animals
– Public Goods
• Have a commercial value - threatened with extinction
– Buffalo
» North America
» Hunting to near extinction - 19th century (from trains)
– Elephants (Ivory)
» African countries
» Hunting – today
– Private good
• The cow
– Commercial value
– Species - continue to thrive
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Why the cow is not extinct
• Elephant - common resource
– No owners
– Poachers - numerous
• Strong incentive to kill them
• Slight incentive to preserve them
• Cows - private good
– Ranches - privately owned
– Ranchers
• Great effort to maintain the cattle population on his ranch
• Reaps the benefit
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Why the cow is not extinct
• Government intervention – help elephant
population
– Kenya, Tanzania, and Uganda (CAC solution)
• Illegal to kill elephants; Illegal to sell ivory
• Hard to enforce
• Elephant population – still diminishing
– Botswana, Malawi, Namibia, and Zimbabwe
• Elephants – private good
• Allow people to kill elephants
– Only those on their own property
• Landowners - incentive to preserve elephants
• Elephant population – started to rise
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