Lecture 4
Chapter 4
Public Goods

What we are going to do
◦ Definitions
◦ Examples
Rivalry – If someone consumes a good,
then no one else can
 Excludability – If you don’t pay, you don’t
get the good.
 Private Goods: Goods that are rival and
Excludable

 Result in no Externalities
Public Goods

Public Good
◦ you can’t stop people from consuming it
(nonexcludeable)
◦ Your consumption doesn’t affect other’s
consumption (nonrivalrous)
Public goods are associated with
externalities because no one has a
property right to a public good.
 Public goods lead to free riding

 Benefiting from a good without paying for it.
Public Goods

Examples of Rivalry
◦ Is Satellite TV rivalrous?
 No, it is nonrivalrous
◦ Is it Satellite TV exludable?
 Yes, they can turn off your service
◦ Is it a public good then?
 No, a good has to be both nonrivalrous and
nonexcludable.
Public Goods

Example of Excludability
◦ Is fishing international waters excludable?
 No, who is going to enforce?
 Think Whale Wars
◦ Is it rivalrous?
 Yes, there are only so many fish in the ocean?
◦ Is it a public good?
 No, because it is rivalrous
Public Good Examples

National Defense
◦ Rivalrous? Excludable?
◦ No. It is a public good because
it is nonrivalrous and
nonexcludable

Fireworks show
◦ Rivalrous? Excludable?
◦ No, it is a public good because
it is nonrivalrous and
nonexcludable
Public vs. Private

Bread
Purely Private
 Total consumed = sum
of individual
consumption
 A market could form
and people could adjust
their consumption
according to their
preferences


Heat
Purely Public
 Everyone feels the same
temp
 Impossible for one to
consume more heat and
exclude the others
 Individuals will not be
able to adjust according
to their preferences
 Everyone Consumes the
same amount

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Is the good
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Cable tv
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National defense
Marginal Cost of allowing additional
consumers to consume a public
good
Once a public good has
been provided, what is
the additional cost of
allowing an additional
person to enjoy the
good?
Don’t confuse distribution with production
Think of the marginal cost of allowing an additional
person watch a fireworks display.
Marginal Cost of Producing A Public
Good
Let’s think production:
Does the fact that a good
is “public” alter how much
it costs to produce
another unit of the good?
Main Point: The marginal cost of producing a public good is
positive for each unit (the constant marginal cost curve is for
simplicity of explanation)
Good Classification

Goods vary in their levels of excludability
and Rivalry
Provision of Public and Private
Goods
What is the traditional way that we
believe private goods are provided to
consumers?
 Public Goods?
 What are examples of goods that are
both provided privately and by the
government?

◦ Tennis Courts, Education, Golf Courses
Congestible Public Goods

Def: Goods for which crowding or
congestion reduces the benefits to
existing consumers when more
consumers are accommodated
◦ Marginal cost of accommodating an additional
consumer is not zero after the point of
congestion is reached
Example: a user of a congested road
decreases the benefits to existing users
by slowing traffic, increasing accident risk
 Other Examples?

Congestible Public Goods

How do we graphically present a
congestible public good?
Price-Excludable Public Goods
Def: Goods with benefits that can be priced
 Can be individually consumed and are subject
to exclusion, but their production and
consumption is likely to generate externalities

◦ Membership rights to private clubs
◦ Schools, hospitals, transportation
Is higher education a pure public good?
 Why Does the Government fund Higher
Education then?

Annotated Bibliography

Def: An annotated bibliography is a list of citations to
books, articles, and documents. Each citation is followed
by a brief (usually about 150 words) descriptive and
evaluative paragraph, the annotation.
 The purpose of the annotation is to inform the reader
of the relevance, accuracy, and quality of the sources
cited.
 Alphabetical Order by last name of first author
 Citation Style
 Notes are what you need to write your paper
 At least six total references, two from peer reviewed
journal articles
 Due Date: October 20th
 Where to find peer reviewed journal articles?
Market Demand for a Purely Private good
– Think Horizontal


Each Individual chooses how much they want at each
price
Demand for a purely Private good is the horizontal
summation of the individual demand curves.
◦ Make sure demand is solved as Q a function of P, then
add. For Example Q= 20 – 2P
Price
of ice
cream
S=SMC
$3
$2
DJERRY
0
QJERRY QBEN QTOTAL
Notice
MBJerry = MBBen = MSC  Efficiency
DBEN
SMB =DBEN+JERRY
Quantity
of ice
cream
Demand for Pure Private Good
•Notice how the marginal conditions for
efficiency are met:
•MBA = MBB = MBC = MC
•Also notice that these are prices per loaf
Demand for Pure Public
Goods – Think Vertical

All consumers must
consume the same
quantity of the good
◦ Pure public goods cannot be
divided into individual units



Demand for public good
is the maximum
individuals are willing to
pay for the amount of the
good that is available
Demand for public good
is the vertical summation.
Think Price as a function
of quantity, P = 10 - .5Q
Price of
missiles
$6
S=SMC
DJERRY
$4
$3
SMB=DBEN+JERRY
$2
$2
DBEN
$1
0
1
5
Notice: the sum of the marginal benefits equal the
marginal social cost.
Quantity of
missiles
Demand for Pure Public Goods

For one Guard:
◦
◦
◦
◦
Person A is willing to pay $300,
person B $250
person C $200
 Total for one guard
= $750
You Try
Bill’s demand for hamburgers (a private good) is
Q = 20- 2P and Ted’s demand is Q = 10 – P
1. Write down an equation for the social marginal
benefit of the consumption of the hamburger
2. Now suppose that hamburgers are a public
good. Write down an equation for the social
marginal benefit of hamburger consumption.

You Try

a)
b)
c)
d)
Quantity
Alice
Ben
Carolyn
Don
1
1000
800
600
400
2
800
600
400
200
3
600
400
200
100
4
400
200
100
50
The table shows how the marginal benefit of a service varies for four
consumers.
Suppose the service is a pure private good and is sold in a competitive
market with only buyers being the four in the table. If the market price
of the product is $400, what is the quantity demanded?
Suppose the service is a pure public good. What is the marginal social
benefit of two units of service?
If the MSC of the good is $2,000 what is the efficient output assuming
that it is a pure private good?
If the MSC of the good is $2,000 what is the efficient output assuming
that it is a pure public good?
Efficiency of a Pure Public Good
Review: The marginal social benefit of any
given amount of a pure public good is the
sum of the individual marginal benefits
received by all consumers.
 Efficient quantity per time period
corresponds to the point at which output
is increased so that the sum of marginal
benefits to consumers equals marginal
social cost of the good.
 Efficiency conditions are:
i

i
•From the perspective of Society
•Is one security guard efficient?
•Are two security guards
efficient?
•Are three security guards
efficient?
How to finance public goods

Lindhal Pricing: When each person pays an
amount equal to their marginal benefit.
◦ The government provides the public good and
finances its provision through each person
paying what it is worth to them
Examples

International View
◦ When Iraq invaded Kuwait in 1990, which countries were
at risk?
◦ Estimates of the cost of the war = $61 billion
◦ $54 billion came from other nations
 $17 billion from Saudi Arabia
 $16 billion from Kuwait
 $11 billion from Japan
◦ US left with $7 billion of the incremental costs of fighting
the war.
How is this like a Lindahl equilibrium?
 PROBLEM:

◦ If people know that they are required to pay a share of the cost of a
public good dependent on their marginal benefits, they have an
incentive to understate their true marginal benefits.
The Free Rider Problem





Def – A person who seeks to enjoy the benefits of a
public good without contributing anything to the cost of
financing.
This strategy almost guarantees that the equilibrium
amount of a pure public good will be less than the
efficient amount.
Problem becomes more acute in large groups where a
free rider reasons that their contribution is less likely to
be needed or missed
Our government provides lots of public goods, how do
they overcome the free rider problem?
ANS: Compulsory finance! Taxes!
Examples
 WNYC has an estimated listening audience of 1 million people,
but only 7.5% of their listeners support the station. In the
United Kingdom, the BBC charges an annual licensing fee to
anyone who owns and operates a TV.
 A 2000 study of the file-sharing software Gnutella showed that
70% of users download files only from others. The file-sharing
software Kazaa assigns users ratings based on their ratio of
uploads to downloads and then gives download priority to
users according to their ratings.
 Cambridge, England, tried to provide 350 free green bicycles
scattered throughout the city. Users were expected to return
each bicycle to one of 15 stands after its use. Within four days,
not a single bicycle could be found, most having been likely
stolen and repainted.
 In Lexington KY, the system worked better, 95% retention rate of bicycles
Examples
Business
Improvement Districts
It is infeasible to charge pedestrians a fee for using the streets, so
cities use tax revenues to provide police, sanitation, and public
works departments. Public provision of these services does not
always work effectively.
Example: New York City’s Times Square
 The city government spent ten years attempting to clean up Times Square.
 A group of local businessmen decided to start a Business Improvement
District (BID), a legal entity that privately provides local services, and funds
these services with fees charged to local businesses.
 New York law is structured so that if the BID organizers can get over 60%
of the local business community to join, then the BID can (think of a law)
levy fees on all local businesses.
Results:
 Crime has dropped significantly.
 The area is cleaner and more attractive.
 Business and tourism are booming.