Chapter 16
Public Goods
and Public Choice
© 2009 South-Western/ Cengage Learning
Private, Public Goods, and in Between
1. Private goods
– Rival in consumption
– Exclusive
– Provided by private sector
2. Public goods
– Nonrival in consumption
– Nonexclusive
– Provided by government
2
Private, Public Goods, and in Between
3. Natural monopoly
– Nonrival but exclusive
– With congestion: private goods
– Provided by private sector or government
4. Open-access good
– Rival but nonexclusive
– Regulated by government
3
Exhibit 1
Categories of goods
4
Optimal Provision of Public Goods
• Nonrival in consumption
– Once produced: available to all
consumers
• Market demand curve
– Vertical sum of individual demand curves
– Marginal benefit
• Efficient level of public good
– Market D curve intersects MC curve
5
Exhibit 2
Market for public goods
D
e
$15
Marginal cost
Dollars per hour
Da
Because public goods, once
produced, are available to all in
identical amounts, the demand
for a public good is the vertical
sum of each individual’s demand.
The market demand for mosquito
spraying (D) is the vertical sum
of Maria’s demand, Dm, and
Alan’s demand, Da.
10
Dm
5
D
0
2
Hours of mosquito
spraying per week
The efficient level :MC of mosquito spraying equals its marginal
benefit; at point e, where the marginal cost curve intersects the
market demand curve .
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Paying for Public Goods
• Tax = marginal valuation
– Free-rider problem
• People try to benefit from the public goods
without paying for them
– Ability to pay
7
Public Choice in Representative
Democracy
• Public choices
– Government decisions
• Public goods
• Taxes
• Median-voter model
– The preference of the median voter will
dominate other choices
8
Special Interest and Rational Ignorance
• Elected officials: Maximize political
support
– Special interest rather than
– Public interest
• Asymmetry
• Voters ‘rational ignorance’
9
Distribution of Benefits and Costs
1. Widespread benefits; widespread costs
– Traditional public-goods legislation
– Positive impact on economy
•
Total benefits > total costs
2. Concentrated benefits; widespread costs
– Special-interest legislation
– Harms the economy
•
Total costs > total benefits
– Pork-barrel spending
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Distribution of Benefits and Costs
3. Widespread benefits; concentrated costs
– Populist legislation
– Beneficiaries: rationally ignorant
4. Concentrated benefits; concentrated
costs
– Competing-interest legislation
– Fierce political battles
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Exhibit 3
Categories of legislation based on the distribution of
costs and benefits
12
Farm subsidies
• The Agricultural marketing agreement
act, 1937
– Prevent ‘ruinous competition’
– One in four Americans: farm
– Floor prices
• 2007
– One in fifty Americans: farm
• $18 billions a year
13
Farm subsidies
• To subsidize farmers, consumers pay
– Higher product price
– For the surplus (taxpayers)
– For storage (the government buys the
surplus)
– E.g. milk
• Free market p=$1.50
• Subsidized p=$2.50+$2.50+$0.50
• Farmers: normal profit
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Exhibit 4
Dollars per gallon
Effect of milk price supports
Excess quantity supplied
$2.50
1.50
D
0
75 100
150
No government intervention:
market price = $1.50 per gallon,
and 100 million gallons are sold
S per month.
Government: floor price = $2.50
per gallon, quantity supplied
increases and the quantity
demanded decreases.
To maintain the higher price, the
government must buy the excess
quantity at $2.50 per gallon.
Millions of gallons
per month
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Rent Seeking
• Activity interest groups undertake
– Secure special favors from government
• Political action committees
• Shift resources from production
• No incentive for economic efficiency
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Campaign finance reform
•
•
•
•
•
Special-interest money
Soft money
Hard money
Money matters more to challengers
Efforts to limit campaign spending
17
The Underground Economy
• Unreported market activity
– To avoid taxes
– Illegal
• Tax avoidance
– Legal
– Pay least possible tax
• Tax evasion
– Illegal
– No or fraudulent tax return
18
The Underground Economy
• Underground economy grows more
– Government regulation increase
– Tax rates increase
– Government corruption widespread
• Estimated: $1.4 trillion in 2007
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Bureaucracy in Representative
Democracy
• Bureaus
– Government departments, agencies
• Ownership
– Taxpayers
• Funding
– Government appropriation
• Less incentive to eliminate waste and
inefficiency
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Bureaucracy in Representative
Democracy
• Bureaucratic objectives
– Serve the public
– Maximize budget
• Larger budget than desired by median voter
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Bureaucracy in Representative
Democracy
• Private vs. public production
– Private production – may be more
efficient
– Public production – preferred by public
officials
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