Public Goods
Lecture 11 – academic year 2014/15
Introduction to Economics
Fabio Landini
What do we do today?
• Lect. 11: what happens when markets
cannot provide a price for goods?
• Lect. 11: what’s the difference between
private goods and public goods?
• Lect. 11: how can we come avoid
opportunistic behaviour (free rider)?
Common resources
• What happens
when natural
resources finishes
(e.g. fish)?
• Which countries
and/or citizens
have to pay for
such resources?
3
Public goods
• Who decides how
much we should
spend for the public
sector?
• What could happen
if everyone stop
paying taxes?
The allocative function of prices
In our economic system (private capitalism)
most goods are allocated though the market
mechanism.
For these goods, the price is the reference
point for consumers (how much to buy) and
producers (how much to sell).
Not everything has a price…
However, there are also free goods (nice walk in
Parco Ducale).
For free goods, markets are not good devices to
design the allocation of the resources.
The price does not reflect the consumers’
willingness to pay.
Indeed, the price cannot equalize supply and
demand.
Not everything has a price…
In this case:
Public intervention
can solve market failure & increase economic
welfare.
Market efficiency and good typology
The efficiency of markets depends on the type
of goods.
The various goods available in our economy
differ along two dimensions
Excludability
and
Rivalry
Typologies of economic goods
Excludability
An individual can be prevented from using a
good (e.g. laws usually recognize the private
property of a good)
Typologies of economic goods
Rivalry
The consumption of a good by an individual
prevents the simultaneous consumption of the
same good by other individuals
Example of a public good: A bridge
A bridge connects two shores of a river
Given a certain dimension of the bridge, if the
n. of people using the bridge increases
(congestion): consumption rivalry
If there is a tax for the bridge (those who don’t
pay cannot use it): consumption excludability
Example of the
bridge
Many
Free access
Rival
N. people
Few
Not rival
Example of the
bridge
Tax
yes
Given
number of
people
No
Not
Excludable
excludable
Example of the
bridge: two-ways
table
Many
N. people
Few
Tax
Yes
No
Excludable
Not excludable
Rival
(PRIVATE GOODS)
Rival
(COMMONS)
Excludabe
Not excludable
Not rival
(NATURAL
MONOPOLY)
Not rival
(PUBLIC GOODS)
Four types of economic goods (1)
Private goods
• Both excludable and rival
Example: ice-cream, CDs, etc.
Public goods
• Neither excludable nor rival
Example: national defence, scientific
knowledge, Wikipedia
Four types of economic goods (1)
Commons
• Rival but not excludable
Example: sea fish.
Natural monopoly
• Excludable but not rival
Example: drinkable water
Public goods and externalities
Non-excludable goods  all can benefit without
paying the price, p = 0
Access to the good cannot be limited; private
value = 0, social value > 0
But: production costs > 0 (scarce resources)
Who is it going to produce the good, if not paid?
Therefore: positive externalities of a public good
(autonomously, market produces too few).
The problem of free riding
A free rider is a person who can enjoy
the benefit of a good without paying
the price
In order to build the bridge, a voluntary
contribution equal to 10 is requested…..
The bridge The bridge is
is built
not built
I contribute
(I pay 10)
90
- 10
I do not
contribute
(I don’t pay)
100
0
It is convenient for me NOT to pay!!!
Free riding in public transport
The problem of free riding
Since public goods are not excludable, each
individual can refuse to pay the good, hoping
that other people will pay in his/her place.
If everybody reasons the same, the good is not
produced.
IMPORTANT: the presence of free riding makes
it impossible to rely on the market to supply
public goods.
Solution of the free riding problem
If the benefits > costs (social value > 0), public
authorities can produce the good by relying on
taxes.
Example: fireworks by Moena’s Municipality
– 500 inhabitants; value for each inhabitant
=10 €; cost of fireworks = 1000 €.
– Fireworks tax for each inhabitant = 2€, it
covers the costs.
– Consumer surplus = 8€ (= 10€ - 2€).
The need for a State to produces public
goods, whose cost is financed via taxes,
represents the main economic justification
for the existence of taxation (and thus for
the fight against tax evasion): that is the
“minimum State”.
Common resources
Common resources are not excludable
They are freely available for anybody to
exploit
But they are rival: the consumption of the
good by one individual reduces the possibility
for other individual to consume
Examples of common resources
• Air and clean water
• Congested streets
• Fishes, whale and other wild species
The tragedy of the commons
When an individual, by using a resource,
diminishes the availability of the resource
for others we encounter the tragedy of the
commons.
Common resources tend to be overexploited
This generates a negative externality.
The tragedy of the commons
The public administration can:
• Impose a tax on usage;
• Regulate the use of the resource;
• Transform the common resource in a private
good (by defining and enforcing individual
property rights on the resource).
The importance of property rights
When the absence of property rights is the cause
of market failures, public intervention can
potentially solve the problem in 3 ways
1) By defining property rights, which enable the
market to operate efficiently;
2) By regulating individual behaviour;
3) By producing a good that the market does
not supply.
Conclusion
Economic goods differ in terms of excludability
and rivalry.
The market can function when goods are
private i.e. both excludable and rival.
Public goods are neither excludable nor rival,
hence the market does not function well.
In because of free riding, it is the public sector
who is responsible to supply public goods.
Conclusion
Collective resources are rival but not
excludable.
Since individuals do not pay for the use of
the resource, there is a tendency toward
over-exploitation.
Public administration may limit the use of
common resources via access regulation
and taxes