PUBLIC GOODS

1. PUBLIC GOODS Chapter 4

2. 0 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

3. Some Public Goods • Basic research • Programs to fight poverty • Uncongested non-toll roads • Fireworks display • Honesty • National Defense

4. Types of Goods NATURAL MONOPOLY PRIVATEGOODS COMMONRESOURCES PUBLICGOODS

5. Noteworthy Aspects of Public Goods • Even though everyone consumes the same quantity of the good, it need not be valued equally by all • Classification as a public good is not absolute; it depends on market conditions and the state of technology • A commodity can satisfy one part of the definition of a public good but not the other • Impure public good: rival or excludable • Some things that are not conventionally thought of as commodities have public good characteristics • Private goods are not always provided only by the private sector • publicly provided private goods: rival and excludable goods provided by govt • Public provision of a good does not necessarily mean that it is also produced by the public sector (e.g. garbage collection)

6. 0 Efficient Provision of Private Goods

7. $ 0 Sf DfA+E DfA DfE Quantity of Pizza

8. Pareto Efficiency – Private 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

9. 0 Efficient Provision of Public Goods

10. $ 0 Sr DrA+E DrA DrE Quantity of Fireworks

11. 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

12. 0 Problems Achieving Efficiency • The Free-Rider Problem • Solutions to the free-rider problem • Perfect price discrimination • Policy Perspective: GPS is non-rival but excludable since technology exist to scramble signals

13. Laboratory Experiments: Do People Free-Ride? • How a typical experiment works • Typical results • People contribute about 50% of resources to provision of public good • Contributions fall the more often the game is repeated • Cooperation fostered by prior communication • Contribution rates decline when opportunity cost of giving goes up • “Warm-glow” giving

14. The Privatization Debate • Privatization – taking services supplied by government and turning them over to the private sector • Public Sector v Private Sector Provision: What is the right mix? • Relative wage and materials costs: less expensive sector preferred on efficiency grounds • Administrative costs: large fixed adm costs can be spread over a large group under public sector • Diversity of tastes: larger diversity better handled by private sector • Commodity egalitarianism: some commodities ought to be made available to everyone better achieved under public sector

15. Public vs Private Production Debate • Which sector is more efficient? • Theory that public sector managers have little incentive to be efficient • However, problems in comparing cost differences since quality of services offered by public and private sectors can differ. (e.g., hospitals) • Incomplete contracts • Competition to supply good or service • Reputation building • Ultimately depends on Market Environment facing the providers

16. Chapter 4 Summary • Public goods are nonrival and nonexcludable in consumption • Impure public goods exhibit some qualities of private and public goods • Efficient provision of public goods: • ∑MRSixy= MRTxyi=person i…..n • An incentive exists to free-ride in the payment of public goods • Public goods can be provided privately; private goods can be provided publicly

17. Public goods Public goods are nonrival and nonexcludable in consumption. Thus, each person consumes the same amount, but not necessarily the preferred amount, of the public good. Efficient provision of public goods requires that the sum of the individual MRSs equal the MRT, unlike private goods, for which efficiency requires that each MRS equals the MRT. The private market is unlikely to provide nonrival goods efficiently, even if they are excludable. Casual observation and laboratory studies indicate that people do not fully exploit free-riding possibilities. Nonetheless, in certain cases, free riding is a significant problem. Public goods can be provided privately, and private goods can be provided publicly. Even when public provision of a good is selected, a choice between public and private production must be made. A key factor in determining whether public or private production will be more efficient is the market environment. Another important question is the extent to which complete contracts can be written with private sector service providers.

18. Appendix: Preference Revelation Mechanisms for Public Goods ∆TEve = MRTra – (MRSraTotal – MRSraEve) Eve’s choice: ∆TEve = MRSraEve By substitution: MRTra – (MRSraTotal – MRSraEve) = MRSraEve Add (MRSraTotal – MRSraEve) to both sides: MRTra = MRSraTotal