Session 3
Public Goods
4-1
Public goods defined
• Goods can be classified according to two
attributes:
– whether they are excludable
– whether they are rival in consumption
• A good is excludable if the supplier of that good
can prevent people who do not pay from
consuming it.
• A good is rival in consumption if the same unit
of the good cannot be consumed by more than
one person at the same time.
4-2
Characteristics of Goods
• Excludable vs. Nonexcludable
– Excludable – preventing anyone from consuming the
good is relatively easy
– Nonexcludable – preventing anyone from consuming
the good is either very expensive or impossible
• Rival vs. Nonrival
– Rival – once provided, the additional resource cost of
another person consuming the good is positive
– Nonrival – once provided, the additional resource cost
of another person consuming the good is zero
4-3
Types of Goods
RIVAL
YES
EXCLUDABLE
YES
NO
PRIVATE
GOODS
NATURAL
MONOPOLY
NO
COMMON
RESOURCES
PUBLIC
GOODS
4-4
Public goods defined
• There are four types of goods:
• Private goods, which are excludable and rival in
consumption, like wheat
• Public goods, which are nonexcludable and
nonrival in consumption, like a public sewer
system
• Common resources, which are nonexcludable
but rival in consumption, like clean water in a
river
• Artificially scarce goods, which are excludable
but nonrival in consumption, like pay-per-view
movies on cable TV
4-5
Public goods defined
Pure public goods Goods that are
perfectly non-rival in consumption and are
nonexcludable.
Impure public goods Goods that satisfy
the two public good conditions (non-rival in
consumption and non-excludable) to some
extent, but not fully.
4-6
Noteworthy Aspects of Public
Goods
• Even though everyone consumes the same quantity of the
good, it need not be valued equally by all
– People differ on how they value public goods- +ve or –ve
e.g. national defence
• Classification as a public good is not absolute; it depends
on market conditions and the state of technology:
publicness is a matter of degree
– impure public good e.g. lighthouse can be impure.
• A commodity can satisfy one part of the definition of a public
good but not the other.
– Characterisation of a commodity depends on the state of
technology and legal arrangements. Streets in certain
cities are excludable.
4-7
Noteworthy Aspects of Public
Goods
• Some things that are not conventionally thought
of as commodities have public good
characteristics.
– E.g. honesty, income distribution and
information.
• Private goods are not always provided only by
the private sector
– publicly provided private goods e.g.
medical services and housing.
• Public provision of a good does not necessarily
mean that it is also produced by the public
4-8
Some Other Public Goods
•
•
•
•
Basic research
Programs to fight poverty
Uncongested non-toll roads
Fireworks display
4-9
Efficient Provision of Private
Goods
•
•
•
•
•
Assume a two people society(Adam and Eve)
Assume 2 pvt goods, apples and fig leaves.
The demand curve for Adam is denoted by DAf
The demand curve for Eve is denoted by DEf
Each person’s dd curve shows how much they
are willing to pay for a particular quantity.
• To get the mkt dd curve we do a horizontal
summation of individual dd curves.
• If we introduce a market ss curve we come up
with an equilibrium in the mkt where SS=DD =>
efficient provision.
4-10
Efficient Provision of Private
Goods
Price Adam
(DfA)
$11
5
Eve
(DfE)
1
Market
(DfA+E)
6
$9
7
3
10
$7
9
5
14
$5
11
7
18
$3
13
9
22
$1
15
11
26
4-11
$
12
11
10
Sf
9
8
7
6
5
4
3
DfA+E
2
1
DfE
0
0
1
2
3
4
5
6
7
8
DfA
9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26
Quantity of Pizza
4-12
Pareto Efficiency – Private
Goods Case
•
•
•
•
•
•
•
Utility maximisation: MRSfa = Pf/Pa
Set Pa = $1
MRSfa = Pf
DfA shows MRSfa for Adam
DfE shows MRSfa for Eve
Sf shows MRTfa
Necessary condition for Pareto efficiency:
MRSfaAdam = MRSfaEve = MRTfa
4-13
Efficient Provision of Public
Goods
• Assume Adam and Eve enjoy fireworks
display.
• Adam and Eve prefer bigger to smaller
shows ceteris paribus
• To determine efficient provision we
compare the marginal benefit and
marginal cost.
• Consumption is nonrival so MB is the sum
of what they are willing to pay.
4-14
Efficient Provision of Public
Goods
Units of Fireworks
1
2
3
4
Adam (DrA)
$300
$250
$200
$150
Eve (DfE)
Market
(DfA+E)
250
$550
200
$450
150
$350
100
$250
4-15
Efficient Provision of Public
Goods
• If the MB>MC efficiency requires that the
extra unit should be bought.
• Efficiency requires that provision of a
public good be expanded until the point at
which the sum of each person’s marginal
valuation on the last unit just equals the
marginal cost.
• In our e.g. to find the group willingness to
pay we add the prices that each would be
willing to pay per quantity: - vertical
4-16
$
800
750
700
650
600
550
500
450
Sr
400
350
300
250
200
150
DrA+E
DrA
100
50
0
DrE
1
2
3
Quantity of Fireworks
4
4-17
Pareto Efficiency – Public
Goods Case
•
•
•
•
•
•
•
MRSfa = Pf/Pa
Set Pa = $1
MRSfa = Pf
DfA shows MRSfa for Adam
DfE shows MRSfa for Eve
Sf shows MRTfa
Necessary condition for Pareto efficiency:
MRSfaAdam + MRSfaEve = MRTfa
4-18
Problems Achieving Efficiency
• The Free-Rider Problem
• The incentive to let other people pay for a
public good while you enjoy the benefits.
• This causes the market to fail to provide
the efficient amount of fireworks.
• Even if consumption is excludable, mkt
provision of a nonrival good is likely to be
inefficient
4-19
Free rider problem
• Solutions to the free-rider problem:
• Perfect price discrimination
– If the entrepreneur knows each person’s dd
curve and if it is impossible to transfer the
good to another person. Then each person
can be charged an individual price based on
their willingness to pay.
– Individual preferences are difficult to
determine so private provision will lead to
inefficiency.
4-20
Policy Perspective
• Global Positioning System – nonrival but
yet excludable
• Becoz the MC of letting another person
receive the signal is zero, efficiency
requires that every person who values the
GPS signal should be allowed to receive it.
• Prior to 2000 signals were not available to
everyone coz of security
concerns.(inefficient)
• Do people free ride?
4-21
Free rider problem and govt
• Efficiency requires govt provision of public
goods.
• Govt can coerce everybody to pay for
public goods.
• There are instances where people have
acted collectively without government
coercion in provision of plc gds.
• The free rider problem becomes an
empirical question.
4-22
The Privatization Debate
• Privatization – taking services supplied by
government and turning them over to the
private sector
• Public v Private Provision: What is the
right mix?
– The mix btwn public and pvt modes of
provision has changed substantially
– During the 19th century govt had less
responsibility for education,police protection,
libraries.
4-23
The Privatization Debate
– Currently there appears to be a trend back to the
private sector for provision of public goods.
• What criteria should be used to select the right
mix of public and private provision?
1.Relative wage and materials costs
– The less expensive sector should be preferred.
2. Administrative costs
– Under public provision fixed admin costs are
spread over a large group
3. Diversity of tastes
Becoz of diversity pvt provision is more efficient
4-24
Distributional Issues
• Commodity egalitarianism – notion that
some commodities ought to be made
available to everyone
4-25
Public versus Private
Production
• Efficiency of private production
• Problems in comparing cost differences
• Incomplete contracts- gvt cannot specify
every contingency in advance
• Competition to supply good or service – is
a way of ensuring efficiency even with
incomplete contracts.
• Reputation building - ensures more
contracts
• Market Environment in which a public or
pvt enterprise operates.
4-26