Chapter
11
Public Goods and Common
Resources
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
2
Criteria Use For Classifying Goods
• Excludability – can people be excluded from
using the good it they don’t pay for it?
– Public Goods (e.g., Fire Station) – NO!
– Common Property (e.g., Parks, Fishery) – NO!
• Rivalry in consumption
– One person’s use diminishes other people’s
use
– Public Goods – No, one individual’s use does
not reduce the amount available to others
– Common Property – Yes! (Trees, Fish)
3
Public Goods & Common Property Resources
• The free-rider problem (can’t exclude)
– Free rider
• Person who receives the benefit of a good but
avoids paying for it
– Public goods – not excludable/non-rival
• Once resource is provided, difficult to exclude
others from benefitting (and making them pay)
for it (e.g., fire station, national defense)
• Private market won’t provide enough
(economically efficient amount)
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3
Education and the social optimum
Price of
Aluminum
Optimum
Supply
(private cost)
External
Benefit
Equilibrium
Social value
(private value
and external benefit)
Demand
(private value)
0
QMARKET QOPTIMUM
Quantity of
Aluminum
In the presence of a positive externality, the social value of the good exceeds the private
value. The optimal quantity, QOPTIMUM, is therefore larger than the equilibrium quantity,
QMARKET.
5
Public Goods & Common Property Resources
– Common Property Resource – also not
excludable, but is rival in consumption
• Can’t exclude others from using/accessing the
resource (fish, timber/forests) -> leads to overuse
and possible exhaustion of the resource
6
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
7
Public Goods
• Some important public goods
– National defense
• Very expensive public good
– Basic research
• General knowledge
– Fighting poverty
• Welfare system
• Food stamps
– Education
8
3
Education and the social optimum
Price of
Aluminum
Optimum
Supply
(private cost)
External
Benefit
Equilibrium
Social value
(private value
and external benefit)
Demand
(private value)
0
QMARKET QOPTIMUM
Quantity of
Aluminum
In the presence of a positive externality, the social value of the good exceeds the private
value. The optimal quantity, QOPTIMUM, is therefore larger than the equilibrium quantity,
QMARKET.
9
Correcting for Positive Externalities
Externalities and Market Inefficiency
• Positive externalities
– Socially optimal quantity
• Greater than market equilibrium quantity
– Government – correct market failure
• Internalize the externality
• Subsidy
11
Effect of a “corrective” subsidy
Public Goods
• The free-rider problem
– Public goods – not excludable, non-rival
• Free-rider problem prevents the private market
from supplying the economically efficient (SMC =
SMB) amount of the good
– Government - can remedy the problem
• If total benefits of a public good > its costs
• Provide the public good (or subsidize it)
• Pay for it with tax revenue
• Make everyone better off
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Correcting for Externalities
• Subsidizing “clean fuels”
– Alternative to taxing “dirty” fuels
– Help individuals realize external benefits
– Finance and/or subsidize production and
consumption of the good
– Overall consumption is increased, illustrated
by a rightward shift in demand
• But have to pick the “right fuels”
– “What would the market do?”
• Subsidize research in new energy
Are lighthouses public goods?
• Lighthouses
– 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
• Doesn’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
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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
• 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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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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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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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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