Lecture 4 Chapter 4

Public Goods

What we are going to do

◦ Definitions

◦ Examples

Rivalry – If someone consumes a good,

then no one else can

Excludability – If you don’t pay, you don’t

get the good.

Private Goods: Goods that are rival and

Excludable Result in no Externalities

Public Goods

Public Good

◦ you can’t stop people from consuming it

(nonexcludeable)

◦ Your consumption doesn’t affect other’s

consumption (nonrivalrous)

Public goods are associated with

externalities because no one has a

property right to a public good.

Public goods lead to free riding Benefiting from a good without paying for it.

Public Goods

Examples of Rivalry

◦ Is Satellite TV rivalrous?

No, it is nonrivalrous

◦ Is it Satellite TV exludable?

Yes, they can turn off your service

◦ Is it a public good then?

No, a good has to be both nonrivalrous and

nonexcludable.

Public Goods

Example of Excludability

◦ Is fishing international waters excludable?

No, who is going to enforce?

Think Whale Wars

◦ Is it rivalrous?

Yes, there are only so many fish in the ocean?

◦ Is it a public good?

No, because it is rivalrous

Public Good Examples

National Defense

◦ Rivalrous? Excludable?

◦ No. It is a public good because

it is nonrivalrous and

nonexcludable

Fireworks show

◦ Rivalrous? Excludable?

◦ No, it is a public good because

it is nonrivalrous and

nonexcludable

Public vs. Private

Bread

Purely Private

Total consumed = sum

of individual

consumption

A market could form

and people could adjust

their consumption

according to their

preferences

Heat

Purely Public

Everyone feels the same

temp

Impossible for one to

consume more heat and

exclude the others

Individuals will not be

able to adjust according

to their preferences

Everyone Consumes the

same amount

Table 1

Defining pure and impure public goods

Is the good rival in consumption?

Yes No

Is the good excludable?

Yes Ice cream Cable tv

No Crowded city sidewalk National defense

If a good is both rival and excludable,

it is a private good.

Ice cream is rival, because my

consumption of it precludes you from

consuming the same ice cream. The

only way for you to consume it is to

make more ice cream.

Ice cream is also excludable,

because I can simply not share my

ice cream with you.

Some goods are “impure” public

goods because they are non-rival,

but they are (to some extent)

excludable.

Cable TV is non-rival, because my

consumption of it in no way

diminishes your consumption.

It is excludable, since the cable

company can simply refuse to hook

up the system. Other goods are “impure” public

goods because they are rival, but not

excludable.

For example, a crowded sidewalk is

rival because your enjoyment is

reduced as more pedestrians also

use the same sidewalk.

Yet it is non-excludable because it is

clearly very difficult to prohibit

pedestrians from using the sidewalk.

Finally, pure public goods are both

non-rival and non-excludable.

National defense is a classic

example. It is non-rival because my

consumption of national defense

protection does not diminish your

consumption of it.

It is also non-excludable, because

once an area is protected, everyone

“consumes” that protection.

Marginal Cost of allowing additional

consumers to consume a public

good

Don’t confuse distribution with production

Think of the marginal cost of allowing an additional

person watch a fireworks display.

Once a public good has

been provided, what is

the additional cost of

allowing an additional

person to enjoy the

good?

Marginal Cost of Producing A Public

Good

Main Point: The marginal cost of producing a public good is

positive for each unit (the constant marginal cost curve is for

simplicity of explanation)

Let’s think production:

Does the fact that a good

is “public” alter how much

it costs to produce

another unit of the good?

Good Classification

Goods vary in their levels of excludability

and Rivalry

Provision of Public and Private

Goods What is the traditional way that we

believe private goods are provided to

consumers?

Public Goods?

What are examples of goods that are

both provided privately and by the

government?

◦ Tennis Courts, Education, Golf Courses

Congestible Public Goods Def: Goods for which crowding or

congestion reduces the benefits to

existing consumers when more

consumers are accommodated

◦ Marginal cost of accommodating an additional

consumer is not zero after the point of

congestion is reached

Example: a user of a congested road

decreases the benefits to existing users

by slowing traffic, increasing accident risk

Other Examples?

Congestible Public Goods

How do we graphically present a

congestible public good?

Price-Excludable Public Goods

Def: Goods with benefits that can be priced

Can be individually consumed and are subject

to exclusion, but their production and

consumption is likely to generate externalities

◦ Membership rights to private clubs

◦ Schools, hospitals, transportation

Is higher education a pure public good?

Why Does the Government fund Higher

Education then?

Annotated Bibliography

Def: An annotated bibliography is a list of citations to

books, articles, and documents. Each citation is followed

by a brief (usually about 150 words) descriptive and

evaluative paragraph, the annotation.

The purpose of the annotation is to inform the reader

of the relevance, accuracy, and quality of the sources

cited.

Alphabetical Order by last name of first author

Citation Style

Notes are what you need to write your paper

At least six total references, two from peer reviewed

journal articles

Due Date: October 20th

Where to find peer reviewed journal articles?

Market Demand for a Purely Private good

– Think Horizontal Each Individual chooses how much they want at each

price

Demand for a purely Private good is the horizontal

summation of the individual demand curves.

◦ Make sure demand is solved as Q a function of P, then

add. For Example Q= 20 – 2P

Quantity

of ice

cream

Price

of ice

cream

0 QBEN

SMB =DBEN+JERRY

QTOTAL

$2

S=SMC

$3

DBEN DJERRY

QJERRY

Notice

MBJerry = MBBen = MSC Efficiency

Demand for Pure Private Good

•Notice how the marginal conditions for

efficiency are met:

•MBA = MBB = MBC = MC

•Also notice that these are prices per loaf

Demand for Pure Public

Goods – Think Vertical

All consumers must

consume the same

quantity of the good

◦ Pure public goods cannot be

divided into individual units

Demand for public good

is the maximum

individuals are willing to

pay for the amount of the

good that is available

Demand for public good

is the vertical summation.

Think Price as a function

of quantity, P = 10 - .5Q

$2 $2

Quantity of

missiles

Price of

missiles

0

SMB=DBEN+JERRY

$4 S=SMC

$6

DBEN

DJERRY

1

$3

$1

5

Notice: the sum of the marginal benefits equal the

marginal social cost.

Demand for Pure Public Goods

For one Guard:

◦ Person A is willing to pay $300,

◦ person B $250

◦ person C $200

◦ Total for one guard

= $750

You Try

Bill’s demand for hamburgers (a private good) is

Q = 20- 2P and Ted’s demand is Q = 10 – P

1. Write down an equation for the social marginal

benefit of the consumption of the hamburger

2. Now suppose that hamburgers are a public

good. Write down an equation for the social

marginal benefit of hamburger consumption.

You Try

The table shows how the marginal benefit of a service varies for four

consumers.

a) Suppose the service is a pure private good and is sold in a competitive

market with only buyers being the four in the table. If the market price

of the product is $400, what is the quantity demanded?

b) Suppose the service is a pure public good. What is the marginal social

benefit of two units of service?

c) If the MSC of the good is $2,000 what is the efficient output assuming

that it is a pure private good?

d) If the MSC of the good is $2,000 what is the efficient output assuming

that it is a pure public good?

Quantity Alice Ben Carolyn Don

1 1000 800 600 400

2 800 600 400 200

3 600 400 200 100

4 400 200 100 50

Efficiency of a Pure Public Good

Review: The marginal social benefit of any

given amount of a pure public good is the

sum of the individual marginal benefits

received by all consumers.

Efficient quantity per time period

corresponds to the point at which output

is increased so that the sum of marginal

benefits to consumers equals marginal

social cost of the good.

Efficiency conditions are:

i

i

•From the perspective of Society

•Is one security guard efficient?

•Are two security guards

efficient?

•Are three security guards

efficient?

How to finance public goods

Lindhal Pricing: When each person pays an

amount equal to their marginal benefit.

◦ The government provides the public good and

finances its provision through each person

paying what it is worth to them

Examples

International View

◦ When Iraq invaded Kuwait in 1990, which countries were

at risk?

◦ Estimates of the cost of the war = $61 billion

◦ $54 billion came from other nations

$17 billion from Saudi Arabia

$16 billion from Kuwait

$11 billion from Japan

◦ US left with $7 billion of the incremental costs of fighting

the war.

How is this like a Lindahl equilibrium?

PROBLEM:

◦ If people know that they are required to pay a share of the cost of a

public good dependent on their marginal benefits, they have an

incentive to understate their true marginal benefits.

The Free Rider Problem

Def – A person who seeks to enjoy the benefits of a

public good without contributing anything to the cost of

financing.

This strategy almost guarantees that the equilibrium

amount of a pure public good will be less than the

efficient amount.

Problem becomes more acute in large groups where a

free rider reasons that their contribution is less likely to

be needed or missed

Our government provides lots of public goods, how do

they overcome the free rider problem?

ANS: Compulsory finance! Taxes!

Examples WNYC has an estimated listening audience of 1 million people,

but only 7.5% of their listeners support the station. In the United Kingdom, the BBC charges an annual licensing fee to anyone who owns and operates a TV.

A 2000 study of the file-sharing software Gnutella showed that 70% of users download files only from others. The file-sharing software Kazaa assigns users ratings based on their ratio of uploads to downloads and then gives download priority to users according to their ratings.

Cambridge, England, tried to provide 350 free green bicycles scattered throughout the city. Users were expected to return each bicycle to one of 15 stands after its use. Within four days, not a single bicycle could be found, most having been likely stolen and repainted.

In Lexington KY, the system worked better, 95% retention rate of bicycles

Examples

It is infeasible to charge pedestrians a fee for using the streets, so

cities use tax revenues to provide police, sanitation, and public

works departments. Public provision of these services does not

always work effectively.

Example: New York City’s Times Square

The city government spent ten years attempting to clean up Times Square.

A group of local businessmen decided to start a Business Improvement District (BID), a legal entity that privately provides local services, and funds these services with fees charged to local businesses.

New York law is structured so that if the BID organizers can get over 60% of the local business community to join, then the BID can (think of a law) levy fees on all local businesses.

Results:

Crime has dropped significantly.

The area is cleaner and more attractive.

Business and tourism are booming.

Business Improvement Districts