Public Goods
PhD. Anto Bajo,
Faculty of Economics and Business,
University of Zagreb
What is a Public Good?
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Book refers to two characteristics:
– Nonrival
– Nonexcludable
•
I prefer different terminology:
– Collective consumption
– Exclusion is not feasible
•
It is easy to confuse the terms nonrival and nonexcludable.
•
Collective consumption is almost self defining.
What is Collective Consumption?
•
Collective consumption means that more than one individual can consume the same
product without diminishing the consumption (or utility) of another person.
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A handy rule of thumb is that MC = 0 for one additional consumer.
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This is in contrast to individual consumption wherein two people cannot consume
the same product.
– An apple would be an example of an item that is characterized by individual
consumption. (The MC of one more apple to consume is not 0.)
– A fireworks display would be an example of an item that can be consumed
collectively. (The MC of one more person viewing the display is 0.)
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Note: we do not say that another person is excluded when we consume an item that
is characterized by individual consumption. We refer to such a case as “rival in
consumption.”
•
Excludability means something else.
1
Name some goods that are characterized by
collective consumption (nonrival)
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National Defense
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Police protection
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Fireworks displays
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Roads and highways
– Sometimes not.
– Problems with congestion.
– Sometimes we use the term, “congestible public goods.”
•
Education—maybe, maybe not. We’ll look at education in a bit more
detail later.
•
Health care—maybe, maybe not.
Public vs. private
– Even though everyone consumes the same quantity of the good it need
not be valued equally by all (defense).
– Classification as a public good is not an absolute; it depend on market
conditions and the state of technology (lighthouse).
– A commodity can satisfy one part of the definition of public good and not
other (seaside).
– Some things that are not conventionally thought of as commodities have
public good characteristics (honesty, fair income distribution).
– Private goods are not necessary provided exclusively by the private
sector (medical services, housing).
– Public provision of a good does not mean that it is also produced by the
public sector.
What is Excludability?
•
Here we must put the discussion in terms of private ownership and the
ability of the owner to exclude others by charging a price.
•
Thus, the price system is the heart of our ability to exclude.
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Can you be excluded from national defense if you don’t pay for it?
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No! It is not feasible to exclude.
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Since consumption is collective (nonrival), and since it is not feasible to
exclude (nonexcludable), then national defense is a perfect example of a
pure public good.
•
Could there be such a thing as an “impure public good?”
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The Public vs. Private Continuum
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Soft drinks vs. national defense is easy enough to
understand.
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But what about interstate highways?
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How do they differ from city streets?
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How does an irrigation system fit in?
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What about movies? What about television?
Source: Holcombe Randall G.
Pubic Finance: Government
Revenues and Expenditures in the
Unites States Economy. West
Publishing Company. 1996.
The Free Rider Problem
•
Since exclusion is not feasible with pure public goods, how do you pay for
them?
•
Some public spirited citizen could provide them—not!
•
Voluntary contributions?
– If I decide not to pay, can I be excluded?
– No! I can become a free rider.
•
Because of the free rider problem, many pure public goods are provided by
the government. They collect taxes, then provide the good, without charge.
•
(Note: good is not free!)
Excluding collective consumption goods
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Suppose some enterprising entrepreneur discovered how to exclude
customers from consuming a collective consumption good.
•
Suppose he discovered that he could build a fence around a football field
and charge admission.
•
As long as MC = 0 for adding one more customer, the solution is inefficient.
•
Anytime we charge a price for a collective consumption good, the outcome
is inefficient.
•
Nevertheless, unless a price is charged, the good might not be produced.
•
How many movies would be made if the price was always zero?
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The case for exclusion of a collective
consumption good
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•
•
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There is an important exception.
What if the collective consumption good were being consumed up to the
point of congestion?
Here, the MC of one more consumer is not 0.
In this case, the price system can bring about a more efficient allocation
of resources.
Think of a toll road during rush hour.
New technology allows us to exclude.
What about cable television?
Rosen mentions State Route 91 near LA. It is a four lane highway
accessible only to drivers who buy a particular radio device for their
cars.
When they use the road, they are automatically charged.
Public vs. Private Goods
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We know that in a freely competitive economy, the market will produce an
efficient quantity of all private goods for which there is a market.
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The market fails to produce public goods.
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We know how to find the efficient output of a private good, but what about
a public good?
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First, we must derive the market demand curve, then determine the
efficient level.
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To refresh your memory, let’s start with the market for private goods.
Effective supply of private goods (I)
The derivation of market curves of demand for private goods – the horizontal
summation of the demand curve (assumption: society consists of two people,
there are two private goods)
Pf
Pf
5
Pf
5
5
DfE+Af
DEf
DAf
1
F per year
2
F per year
3
f per year
4
Efficient supply with private goods (II)
equilibrium on the private good market – is established when supply and demand are
identical
Such a distribution is Pareto efficient – at the point of equilibrium the following holds:
MRTjs = MRSjsAdam= MRSjsEve (the curve of market supply is added to the market
demand curves)
Pf
Pf
Pf
Sf
5
5
5
4
4
4
DfE+A
DEf
DAf
1 1½
f per year
2 3
3
f per year
4½
f per year
Vertical vs. Horizontal Summation
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In contrast to private goods, where the market sets the price and each
consumer must choose the quantity that maximizes his utility, everyone
consumes the same quantity of a public good.
•
Thus we fix the quantity and ask, what price is each consumer willing to
pay.
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This result in a demand curve that is derived by vertical summation.
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Not all consumers place the same value on a particular quantity of the
public good.
Efficient supply of public goods (I)
Pr
In order to find common willingness to pay
for a public good one has to aggregate the
prices that two persons are ready to pay
for a given quantity – vertical summation
of demand curves (assumption: society
consists of two persons, there is one
private good)
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DAr
Pr
r per year
20
4
DEr
Each person consumes an equal amount, but
there are Various marginal rate of substitution.
Pr
20
r per year
10
DE+Ar
20
r per year
5
Efficient supply of public goods (II)
Pr
Efficient quantity of supply – the point at
which two persons are ready to pay an
additional quantity of goods is equal to the
marginal cost of the production of this unit.
Equilibrium is set by the condition: MRTra =
MRSraAdam+ MRSraEve
6
4
DAr
Pr
20
DEr
2
Efficient supply requires the provision of a
public good be expanded until the point at
which the sum of the last unit supplied to be
equal to the cost to the society to supply this
unit.
r per year
45
4
Pr
20
45
r per year
10
Sr
6
DE+Ar
20
45
r per year
The Efficient Output of a Public Good
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Notice that the efficient output of the public good occurs at MC = MB.
– MC is the cost to society of producing one more unit.
– It is represented by the supply curve.
– MB is the benefit derived by consuming one more unit by society.
– It is represented by the combined (society’s) demand curve.
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Not everyone is necessarily happy with the market quantity—some may
want more, some may want less.
•
If all are forced to pay the same tax, an individual may end up paying more
or less than his MB.
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This is a distribution of income problem—a matter of equity, not efficiency.
Economic Efficiency
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For private goods, Pareto efficiency requires:
o MRSfaAdam = MRSfaEve = MRTfa
o Assuming we are substituting apples for fig leaves.
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For public goods, Pareto efficiency requires:
o MRSraAdam + MRSraEve = MRTra
o Assuming Adam and Eve are willing to sacrifice apples for more rockets
(national defense).
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This is a direct result of choosing a market quantity, then finding the price
that all participants are willing to pay.
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Unless we are able to practice perfect price discrimination, it is unlikely that
all participants will be paying according to their valuation of the market
quantity.
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Revealed Preference
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Once we decide that a good is a public good and the market has failed to
produce it, we must ask if the government is capable of providing an
efficient quantity.
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The government may provide too much or too little.
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With public goods, there is no revealed preference to guide the market.
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Revealed preference is the key to guiding the private market.
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When we make a purchase, we reveal our preferences to the market, telling
the market how much to produce.
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With public goods, no market information is available to tell the market
how much to produce.
•
So, how is the government to decide, and can they decide on an efficient
quantity?
Political Decision Making
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Decisions on the choice of public goods, i.e., which ones to produce and
how much to produce, are made by our political decision makers.
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Is there any reason to believe that if the market fails to produce an
efficient output that the government will?
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The government may improve the allocation of resources, or it may
cause an efficiency loss. It is unlikely that politicians will make the
efficient decision each time they vote on a budget.
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In chapter 6 we introduce a topic called “Public Choice.”
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Your book refers to it as Political economy.
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In that chapter, we will look at all the influences that can affect political
decision making.
Public vs. Private Provision
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Turning government functions over to the private market. The
privatization debate.
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Some government functions, such as garbage collection, courts, prisons,
can be turned over to the private market.
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Some considerations:
– Relative wage and materials costs
– Administrative costs
– Diversity of tastes
– Distributional effects
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Sometimes, questions of privatization relate more to goods that are
individual consumption than collective consumption.
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Public vs. Private Production
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Public provision means that the government makes the decision to
provide a good that is not produced by the private market.
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Public production means that the government acquires the resources and
produces the good itself.
•
Does government provision necessarily mean that the government should
produce the good?
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Government may provide the good, but it may rely on the private market
to produce it.
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Can you think of examples where the government both provides and
produces a good?
Source: Hyman, David N. Public Finance, A Contemporary Application of Theory to Policy. Harcourt. 2002.
A few of Rosen’s talking points
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Even though everyone consumes the same quantity of the good, this
consumption need not be valued equally by all.
•
Classification as a public good is not an absolute; it depends on market
conditions and the state of technology.
•
Closely related to the previous point, a commodity can satisfy one part of the
definition of a public good and not the other.
•
A number of things that are not conventionally thought of as commodities
have public good characteristics.
•
Private goods are not necessarily provided exclusively by the private sector.
– I might add, public goods are not necessarily provided exclusively by the
public sector.
•
Public provision of a good does not necessarily mean that is also produced
by the public sector.
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