CHAPTER 16
Public Goods
and Tax Policy
Goods Classifications:

Excludable
– can prevent people from consuming
without paying

Rival in consumption
– can not be consumed by more than one
person at the same time
Four types of goods

Private goods:
– excludable and rival in consumption

Collective goods (Artificially scarce goods):
– excludable and non-rival in consumption

Commons goods (common resources):
– non-excludable and rival in consumption

Public goods:
– non-excludable and non-rival in consumption
Four types of goods
Goods Classification
Rival
Excludable
Non-excludable
Non-rival
Private good
(wheat)
Collective good
(pay-per-view TV)
Commons good
(fish in the ocean)
Public good
(national defense)
From Table 16.1, P.365
HW5
Explain the characteristics of the 4
types of goods
 4 types: private; collective; common;
public
 List 5 goods that belong to each of the 4
types and explain

Private Goods:
Excludable and rival in consumption
 Non-payers can be easily excluded
 Each unit consumed by one person
means one less unit available for others
 the only goods that can be efficiently
produced and consumed by market

Collective Good:
(Artificially Scarce Goods)

Excludable but non-rival in consumption
– It is not really scarce: use by one person
does not reduce its availability to others
– But it can be excludable: people who do
not pay can be prevented from using it
Artificially Scarce Goods
An artificially scarce good is excludable and non-rival in consumption. It is
made artificially scarce because producers charge a positive price but the
marginal cost of allowing one more person to consume the good is zero.
Common Goods:
(Common Resources)

Non-excludable and rival in consumption
– Non-payers cannot be easily excluded
– Each unit consumed by one person means one
less unit available for others

The problem of overuse - a user depletes the
amount of the common resource available to
others but does not take this cost into account
when deciding how much to use the common
resource
A Common Resource
Fishing in a public river:
Each fisherman’s
individual marginal cost
does not include the
cost that his or her
actions impose on
others: the depletion of
the common resource 
the marginal social cost
curve, MSC, lies above
the supply curve; in an
unregulated market, the
quantity of the common
resource used, QMKT,
exceeds the efficient
quantity of use, QOPT.
The Efficient Use and Maintenance of a
Common Resource
Use taxes
 Make it excludable and assign property
rights
 Create of a system of tradable licenses
for the right to use the common
resource

Public Good:

A good or service that, at least to some
degree, is both non-rival and nonexcludable
– Non-rival Good
• A good whose consumption by one person
does not diminish its availability to others
– Non-excludable Good
• A good that is difficult, or costly, to exclude nonpayers from consuming
If non-excludable:
Rational consumers won’t be willing to
pay for the good
 People who do not pay can not be
prevented from consuming
 Free-rider problem: individuals have no
incentive to pay for their own
consumption
 Inefficiently low production

If non-rival in consumption
 Marginal
cost = 0
 Price should be 0
 Inefficiently low consumption
What goods and services should
government provide?

Pure Public Good
– A good or service that, to a high degree, is both
non-rival and non-excludable

Pure public goods should be provided by
government because:
– For-profit private firms would find it difficult to
recover their costs of production.
– Since the MC of serving additional users is zero
once the good has been produced, then charging
for the good would be inefficient.
Cost-Benefit Analysis
Social costs and social benefits
 People have no incentive to pay for
efficient quantity of public goods
 People tend to overstate the value of
public goods (people tend to prefer too
much of the goods when they don’t
have to pay for it: marginal cost is 0)

Advantages of Using Government to
Provide Public Goods
Cost of adding a tax is relatively low
 Minimizes the difficulty in determining
who will bear what share of the tax
burden
 May be the only feasible provider

Government Provision
A pure public good should be provided
by the government only when the
benefit exceeds the cost.
 The cost of the public good is the sum
of the explicit and implicit costs incurred
to produce it.
 The benefit of the public good is the
sum of the reservation prices of all
people who want the good.

Government taxes:
the way to finance public goods

Paying for Public Goods
– Not everyone benefits equally from a public
good or service.
– Therefore, the most equitable way to pay
for the public good or service is to tax
people in proportion to their willingness to
pay.
Tax System

Head Tax
– A tax that collects the same amount from
every taxpayer
– A head tax rule will rule out the provision of
many worthwhile public goods.

Proportional Income Tax
– A tax under which all taxpayers pay the
same proportion of their incomes in taxes
Tax System

Regressive Tax
– A tax under which the proportion of income
paid in taxes declines as income rises

Progressive Tax
– One in which the proportion of income paid
in taxes rises as income rises.
Alternatives to using taxes to fund public
goods:
Funding by donation
 Development of new means to exclude
non-payers
 Private contracting
 Sale of by-products

Tax System
 Trade-off
between equality and
efficiency
– Equity: fairness, the “right” people
actually bears the tax burden
– Efficiency: minimizes the direct and
indirect tax collection costs to the
economy
Tax Efficiency
Minimizing
administration
costs (direct costs)
Reducing deadweight loss
(indirect costs)
Recall: excise tax
To Reduce Deadweight Loss
Taxes decreases the price the
producers receive and increases the
price the consumers pay
 The incidence of tax is determined by
the elasticities of demand and supply
 To reduce the deadweight loss caused
by tax, impose taxes on the ones who
have the most inelastic responses

To Lower Administration Costs
 Administration
costs: the
resources actually spent on
collecting and paying the taxes
 The difficulties of calculating,
collecting and paying the taxes
Tax Fairness
 The
benefits principle
–The ones who benefit from the
spending should pay for it
 The
ability to pay principle
–The ones who are more able to
pay should pay for it
The Tax System
Tax bases: the income or property value
that determines how much tax an
individual pays
 Tax Structure: how the tax depends on
the tax base

– Proportional
– Progressive
– Regressive
Tax Bases
（表一）
工资、薪金所得；
2． 个体工商户的生产、经营所得
3． 对企事业单位的承包经营、承租经营所得
4． 劳务报酬所得
5． 稿酬所得
1．
劳动所得
6. 特许权使用费所得；
自有资产
7. 利息、股息、红利所得；
所得
8. 财产租赁所得；
9. 财产转让所得；
偶然所得
10.一些偶然性所得
其他所得
11.经国务院财政部门确定征税的其他所得
Income Redistribution through Taxes and
Government Spending
Progressive taxes: taking more money
away from the rich to provide supports
for the poor
 Government Spending: transfer
payments

– Welfare
– In-kind transfers
– Negative income tax
Income Redistribution:
Social Security
Progressivity
(vertical equity)
Individual equity
Horizontal equity
Economic efficiency
Progressivity:
Redistribution from the better-off to the
less well-off
 Redistribute resources to the elderly
from the rest of the population
(intergenerational redistribution
 Higher rate of return on the
contributions of workers with lower
wages than for those with higher wages
Individual Equity
Ensuring a fair return on contribution
 Individuals should be paid retirement
benefits that, on average, equal their
contributions plus a fair interest rate
 The allocative and distributive functions
of government are combined into a
single program
 Benefits are paid out before adequate
contributions have been built up
Horizontal Equity
Equal treatment for equals
 Equal assessment of payroll taxes on
those with equal earnings
 Equal benefits to those born in the
same year, with equal earnings histories,
and of the same family type
Economic Efficiency
Achieving maximum benefit to society
from available resources
 Minimize any losses of efficiency that
might arise unintentionally