Mod 76 Public Goods & Common Resources Copyright©2004 South-Western MARKET INEFFICIENCY/FAILURES • Recall: Adam Smith’s “invisible hand” of the marketplace leads self-interested buyers and sellers in a market to maximize the total benefit that society can derive from a market. But market failures can still happen. Copyright © 2004 South-Western The Nature of Goods • Up until now, we have always been looking at “Private” goods…goods allocated in markets through a price and supply and demand… BUT • When goods are available free of charge, the market forces that normally allocate resources in our economy are absent Copyright © 2004 South-Western “The best things in life are free. . .” • When a good does not have a price attached to it, private markets cannot ensure that the good is produced and consumed in the proper amounts. Copyright © 2004 South-Western “The best things in life are free. . .” • In such cases, government policy can potentially remedy the market failure that results, and raise economic well-being. • However, government policy might also create a negative outcome, if policies are not well thought-out or followed. Copyright © 2004 South-Western THE DIFFERENT KINDS OF GOODS • For Public Goods and Common Resources, we have an economic model to use for analysis: • It is a matrix that group goods according to two characteristics: • Is the good excludable? • Is the good rival? Copyright © 2004 South-Western THE DIFFERENT KINDS OF GOODS • Excludability • Excludability refers to the property of a good whereby a person can be prevented from using it, usually through a price or charge for it • Rivalry or Shared Consumption • Rivalry refers to the property of a good whereby one person’s use diminishes other people’s use—in other words, that particular good gets used up Copyright © 2004 South-Western THE DIFFERENT KINDS OF GOODS • Four Types of Goods • • • • Private Goods Artificially Scarce Goods—also called “toll goods” Common Resources Public Goods Copyright © 2004 South-Western Four Types of Goods NO—Shared Consumption—YES Rival? Private Goods Yes OR Shared Consumption? Artificially Scarce/Toll Goods • Ice-cream cones • Clothing • Congested toll roads • Fire protection • Cable TV • Uncongested toll roads Common Resources Public Goods • Fish in the ocean • The environment • Congested nontoll roads • Tornado siren • National defense • Uncongested nontoll roads Excludable? No Copyright © 2004 South-Western Private Goods and Toll Goods • Our experience with them • Are they Excludable? • They are allocated by having a price, so they ARE excludable • Are they Rival? • Does my use (owning) of a good “use” that specific good up? Copyright © 2004 South-Western COMMON RESOURCES • Common resources are not excludable. They are available free of charge to anyone who wishes to use them. • However…Common resources are rival goods (or NOT shared consumption) because one person’s use of the common resource reduces other people’s use. Copyright © 2004 South-Western Tragedy of the Commons • The Tragedy of the Commons is a parable that illustrates why common resources get used more than is desirable from the standpoint of society as a whole. • Common resources tend to be used excessively when individuals are not charged for their usage. Copyright © 2004 South-Western Some Important Common Resources • Clean air and water • Fish, whales, and other wildlife Copyright © 2004 South-Western Solving the Common Resource Issue of a Good being over-used b/c it is non-excludable • Governments have several options: • Regulate the common resource • Apply a tax/fees for use of the common resource • Create a system of tradable licenses to use the common resource • Make the common resource excludable by assigning private property rights Copyright © 2004 South-Western PUBLIC GOODS • Public Goods are not excludable, AND they have the quality of shared consumption (nonrival) • Examples: • National Defense • Fireworks • Lighthouses Copyright © 2004 South-Western The Free-Rider Problem • A free-rider is a person who receives the benefit of a good but avoids paying for it. Copyright © 2004 South-Western The Free-Rider Problem of Public Goods • Free-riders say to themselves: “Why should I pay for something when others can get it for free?” • The free-rider problem prevents private markets from supplying these types of goods. • No business wants to provide those goods—it is not worth their while—not enough profit!! • We want these goods, and no business would offer them as a business good b/c their nature makes them not profitable Copyright © 2004 South-Western The Free-Rider Problem • Solving the Free-Rider Problem • The government can decide to provide the public good if the total benefits exceed the costs. Copyright © 2004 South-Western How a Government Decides to provide a Public Good • In order to decide whether to provide a public good or not, the total benefits of all those who use the good must be compared to the costs of providing and maintaining the public good. • Cost benefit analysis refers to a study that compares the costs and benefits to society of providing a public good. Copyright © 2004 South-Western The Difficult Job of Cost-Benefit Analysis • A cost-benefit analysis would be used to estimate the total costs and benefits of the project to society as a whole. • It is difficult to do because of the absence of prices needed to estimate social benefits and resource costs. • The value of life, the consumer’s time, and aesthetics are difficult to assess. Copyright © 2004 South-Western CONCLUSION: Public Goods and Common Resources • When there is a market failure because of the intersection of qualities of excludability and rivalry… • Goods will not be produced or allocated efficiently… • Then, the government often steps in to try to solve the problem. • Such Government Solutions require scrutiny Copyright © 2004 South-Western