Yuh Huei Jang
802 935 645
18.e. Public Goods
Generally, public goods are considered goods that benefit all consumers, such as a city park. However, in
the view of economists, public goods need not be provided by the government. A public good need only
meet two criteria: that it is nonrival consumption, and that there is nonexclusion.
Nonrival Consumption
Given a certain level of production, a good can be considered nonrival in consumption if one’s
consumption of that good does not affect the quantity consumed by other individuals. All individuals that
receive this good benefit from it simultaneously. An example that can be used is that of a crime watch
program. One resident of a community is able to benefit from a lower level of crime, as other also do
simultaneously. Conversely, a good that is rival in consumption diminishes another’s use of that good if an
individual benefits from it. Simultaneous consumption of a good is not possible if a good is rival in
consumption. There include the typical goods that may come to mind, such as televisions, clothing, and
food.
Nonexclusion
A condition that is characterizes nonexclusion can be thought of one in which a good’s benefits may be not
confined (or be prohibitively costly to do so) once produced. National defense is one example of a good
that cannot be excluded. All residents of a country are protected by the service of defense that is
produced—regardless of whether they are a citizen or not. An example of a exclusive good might be public
access content that requires a certain user identification and password for designated areas. The general
information is very accessible to all, but access to more sensitive content may be limited to law
enforcement agencies with the proper authentication.
The Free-Rider Problem
With these two conditions—nonrival consumption and nonexclusion (thus making a public good)—in play,
we can begin to set the foundations for our next topic. A nonrival nonexclusive good shakes up the market
system. No private firm would have incentive to pursue production of such a good because it would be
possible for those who do not pay for it to benefit from it.
This private market may not produce a good even if the benefits to those that would receive it are worth
more than the cost of production. Let’s take for example a public road that needs to be built to replace a
dirt path leading to a new community. The project may have a total cost of $50,000, but the 100 residents
are each willing to pay $1000 for the good. The total benefit of the road to all 100 residents is valued at
$100,000—sufficiently more than the cost it would incur. Why, then, would a private firm not want to
construct the road? Each resident understands that he would be able to still enjoy the road, as long as it was
built, regardless of how much he contributed to its production costs. Each resident, therefore, tries to
understate what the value of the road is, in order to drive the cost to a lower, or zero, cost. An individual
who has an incentive to behave this way, then, is called a free-rider. If enough people behave in this
manner, then the road will not be constructed.
When a good is public, it is understandable why someone would want to be a free-rider. Why pay when
you don’t need to? However, it is this rationale that makes it difficult for a private market to provide this
good for the residents. In fact, the severity of this problem increases as the number of individuals that stand
to benefit increases. As the group sizes increases, it is more likely than before that an individual would
free-ride, thus decreasing the possibility of the good’s providence.
Yuh Huei Jang
802 935 645
Instead of a small community, let us designate the road as one leading to a new town. This town has 5000
residents, each who stand to benefit by a value of $20. The total benefit remains $100,000. Each person
believes that their contribution will not matter, as there are 4999 other residents who may contribute
voluntarily and the road will still be built. In this case, this individual can still benefit from the produced
good without having to pay a dime. As before, however, each person is inclined to think in this manner,
and more so than before because there is a greater drowning-out effect. Fewer people would contribute and
the good would not be produced.
One real-world example of this concept involves a device that General Motors tried to market in the early
1970’s. Before regulatory pollution controls, this device was set to reduce pollution emitted by 30 to 50
percent; it costed $20 per car. It can be seen that the benefit of this far outweighed the mere cost—but
nobody bought this product. Why? For the same reason why the road was not built. The large-group freerider problem prevailed; everyone would have been better off had everyone bought the device, but it was
not in any one individual’s interest to do so. And because it was not in any one person’s interested to do so,
it was not done.
So how do you incite production of something that is of benefit to everybody, but is not produced because
people are scoundrels that look after only themselves and don’t see the larger picture? Communism!
Communism! Communism!
No, just kidding, but you do need government intervention. If in the town everyone was taxed $10 (instead
of asked for a voluntary contribution), the cost of the road $50,000 would be raised. Thus, each person
would receive a $20 benefit for only 10 tax dollars. The government expedition of $50,000 on the road
would be more efficient resource allocation than if the private sector had been relied upon to provided the
good.
Efficiency
We have decided to produce, and how to do so—we now ask ourselves the next fundamental question.
How much do we produce? Predictably, we engage in cost-benefit analysis and play along the margins.
We need to figure out where marginal cost and marginal benefit plot and meet. What is different in this
scenario, however, is that we are dealing with a public good. Such an addition of a nonrival good benefits
no single individual, so we just consider the total of marginal benefits of the whole population in question.
An Example
Figure 18.a.1 below illustrates the demand and supply curves of a public good, waste management services.
We use garbage trucks as a representative. We derive the social marginal benefit curve, MCS (the demand
curve for the whole population) from the demands of the only two people in the community, Jerry and
Huey. Recall that the height of a demand curve is the marginal benefit of an additional unit of a good—this
is why this vertical summation of the demands works.
To illustrate this point, if you add the marginal benefit to Jerry from the first truck, $700, to the marginal
benefit to Huei from the first truck, $500, you receive the social marginal benefit, $1200, of the first unit of
waste management. Continue this and you see that the MB S curve truly is traced out of the vertical
summation of the DJ and DH curves.
Yuh Huei Jang
802 935 645
Dollars per
Truck
1200
MC
1000
700
DJ
600
500
MBS
400
DH
50
Figure 18.a.1
The most efficient
point of production
is where the
vertical summation
of the population’s
demand for the
good, the Social
Marginal Benefit
Curve Marginal
Cost (MBS) meets
the Marginal Cost
(MC). In this case,
$1000 paid for
each of 50 trucks
is where
production should
occur.
Trucks
With this established, we move on to determine where the point of maximum efficiency lies. Realize that
the marginal cost curve, MC, is arbitrarily drawn as a horizontal line for the sake for simplicity. At every
point prior to 50 trucks, Jerry and Huey together are willing to pay more than the trucks cost—so more
units are produced in order to achieve a more efficient output. When MBS lies below the MC curve, more
units are being produced than desired. That is, the cost exceeds the combined benefit to Jerry and Huei of
every truck beyond the 50th. Thus, the most efficient level of output is where the two marginal curves meet,
at 50 units.
Recall that the free-rider problem makes it improbable that the private sector would tackle such a task of
providing a nonrival good; this lends way for the public sector to address the issue. However, it is not so
easy. As it is for most other economic issues, it is virtually impossible to determine how to quantify such
subjective items. How do you measure one’s demand for a good such as a public swimming pool,
highways, or even national defense? You cannot do it accurately, so you cannot possibly precisely quantify
the demands of an entire community for such a good.
Other problems arise. Let us say that you were able to tax an individual according to how much that person
values a benefit at any given output. But, then that individual would understate that benefit as a reaction to
the tax in order to partially free-ride. People will always try to find a way to cheat.
Patents
Initially, it would seem inefficient to exclude (if one could) anyone else from the benefits of a nonrival
good. In general, knowledge is nonrival in consumption. One’s use of it does not take away from
another’s ability to. However, acquiring knowledge, or research, does require the input of resources. A
party devoting time and money into the research of a new vaccine or drug would have no incentive to do so
if they were not able to keep that knowledge a private asset. If they were not able to protect it—or not able
to patent—then the free-rider problem arises again and life-saving drugs may never be discovered. The
public policy of patents preserves the inducement for advances to be made that could be bolstered by a
profit incentive. This protection also tends to an inefficiently distributed; however, the benefits must be
weighed against the costs, again.
Yuh Huei Jang
802 935 645
Questions
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
Define what it means for a good to be nonrival in consumption.
Give an example of a good that is nonrival in consumption.
Define what it means for a good to be nonexclusive.
Give an example of a good that is nonexclusive.
What can a good be considered if it fulfills both criteria mentioned above?
Define what it means to be a free-rider.
Give an example of how you have been a free-rider
Give a solution for which a public good may be provided in spite of the free-rider effect.
Name the process by which the social marginal benefit curve is derived.
At what point is production most efficient for a public good?
Answers
A good can be considered nonrival in consumption if one’s consumption of that good does not
affect the quantity consumed by other individuals.
2. Does the answer fit the definition above?
3. A condition that is characterizes nonexclusion can be thought of one in which a good’s benefits
cannot be confined (or be prohibitively costly to do so) once produced.
4. Does the answer fit the definition above?
5. A public good.
6. A individual who understates his/her benefit from a good in order to drive his/her own cost lower
or to zero.
7. It’s your fault that we have air pollution! All your fault!
8. Government implementation/ tax remedies.
9. Vertical summation, of individual demand curves.
10. When the good is produced at a point in which Marginal Cost meets the Marginal Benefit to
society.
1.