Download Public Goods Chapter 4

Chapter 4
Public Goods
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Public Goods

Public Goods are goods for which
exclusion is impossible.
 One example is National Defense: A
military that defends one citizen
from invasion does so for the entire
public.
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Characteristics of Public Goods

Nonexclusion: The inability of a seller to
prevent people from consuming a good if
they do not pay for it.

Nonrivalry: The characteristic that if one
person “consumes” a good, another person’s
pleasure is not diminished, nor is another
person prevented from consuming it.
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Pure Public Goods and
Pure Private Goods


Pure Public Good: No ability to exclude
and no rivalry for benefits.
Pure Private Good: Clear ability to
exclude and rivalry for benefits.
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Marginal Costs for Provision of
Public Goods

The marginal cost of allowing
another person to benefit from a
pure public good is zero, while the
marginal cost of providing a
greater level of public good is
positive.
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Figure 4.1 Marginal Costs of Consuming and
Producing a Pure Public Good-Figure A
Cost (Dollars)
200
Marginal Cost of Allowing an
Additional Person to Consume a
Given Quantity of Pure Public Good
0
1
Number of Consumers
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Figure 4.1 Marginal Costs of Consuming and
Producing a Pure Public Good--Figure B
Marginal Cost of Producing
a Pure Public Good
MC = AC
Cost (Dollars)
200
0 Units of a Pure Public Good per Year
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Example:Bread versus Heat

Bread – Clearly a pure private good
because there is the ability to exclude
and there is rivalry to consume.

Heat – Clearly a pure public good
because there is no ability to exclude
and there is no rivalry to consume.
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Provision of Private Good and
Public Goods: Markets and
Government
Price Excludable Public Goods
vs
Congestible Public Goods
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Price Excludable Public Goods
Excludability, but no rivalry

Another type of good is a priceexcludable public good: no rivalry but
exclusion is easy.
Examples: Country Clubs, Cable TV
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Congestible Public Goods
Rivalry but no excludability

There are public goods where, after a
point, the enjoyment received by the
consumer is diminished by crowding or
congestion. These are called
Congestible Public Goods.

Examples: roads and parks
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Marginal Cost
Figure 4.2 A Congestible Public Good
Marginal Cost per User
0
1
Number of Consumers per Hour
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Figure 4.3 Classifying Goods According to the Degree of
Rivalry and Excludability of Benefits from Their Use
A
1
C
H
B
0
1
Rivalry
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Education as a Public Good


Education is a service that has some characteristics of a
public good and some characteristics of a private good.
External benefits





It helps us live in a civil society.
It has a “socializing ” function.
It teaches the importance of following rules, obeying orders, and
working together.
It provides students with basic skills like punctuality and the
ability to follow directions that increase their productivity as
workers.
It helps students identify their abilities and choose appropriate
occupations, thereby increasing productivity levels for a nation.
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Education as a Private Good

Education has characteristics of a private good.



Wide disparities exist in the quantity and quality of
education provided among school districts.
The level of support that parents can give students at
home increases with income and home support is an
important factor in learning for children.
There is no way to prevent parents who want more
than a standardized quantity and quality of education
for their children from buying it in the marketplace.
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Demand For a Pure Public Good


Market demand for a Pure Private
Good is derived by adding quantities
demanded at each price.
Demand for a Pure Public Good is
derived by adding how much people
will be willing to pay at each quantity.
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Price per Loaf of Bread (Dollars)
Figure 4.4 Demand For a Private Good
7
6
5
4
E
3
S = MC = AC
D = QD
DC = MBC
DB = MBA
DA = MBA
2
1
0
1
2
3
4
5
6
7
8
9
10
Loaves of Bread Purchased per Week
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Marginal Benefit (Dollars)
Figure 4.5 Demand For A Pure Public Good
800
Z1
700
600
500
400
300
200
100
0
Z2
Z3
Z4
D= MBA
DA = MBA
DB = MBB
DC = MBC
1
2
3
4
5
Security Guards per Week
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Marginal Benefit (Dollars)
Figure 4.6 Efficient Output for a Pure Public Good
800
700
600
500
E
MC = AC = MSB
400
300
200
100
0
D= MBi = MSB
MBA
MBB
MBC
1
2
3
4
5
Security Guards per Week
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Efficient Output of a
Pure Public Good

The socially optimal level of the public good
requires that we set the Marginal Social
Benefit of that good equal to its Marginal
Social Cost. MSB = MSC


Lindahl Pricing: Everyone in a group cooperates and
participants each pay their marginal benefit.
 We can demonstrate this issue mathematically,
numerically (using a table), and graphically.
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Mathematically: Lindahl Pricing
Recall from Figure 4.5 that the marginal
social benefit for a pure public good is the
sum of the individual marginal benefits.
That is:
MSB = MB.
Efficient output is therefore:
MSB = MB = MSC.
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Numerically: Lindahl Pricing

Suppose we have three people who
are discussing the issue of hiring
security guards. Note that each
person places a different value on
the levels of security.
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A Numerical Example
Number of Security Guards per Week
1
2
3
4
MBA
$300
$250
$200
$150
MBB
$250
$200
$150
$100
MBC
$200
$150
$100
$50
MB
$750
$600
$450
$300
If the cost of security guards is $450 per week, then no individual will
hire even one guard, even though to the group one guard is worth
$750. The group should hire three.
If they each pay their marginal benefit, then three guards are hired.
Person A pays $600 ($200 per guard), person B pays $450 ($150 per
guard) and person C pay $300 ($100 per guard).
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Lindahl Equilibrium


The amount each person contributes, ti,
depends on individual desires for the public
good.
The sum of the contributions equals the total
cost of the public good.



tiQ* = MC(Q*) = AC(Q*)
ti = MC = AC
All individuals agree to pay their shares.
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Freeriding

Freeriding occurs when people
are not honest in stating their
Marginal Benefit, because if
they understate it, they can get
a slightly reduced level of the
public good while paying
nothing for it.
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Freeriding is easier with

Anonymity: If everyone knows who
contributes, there can be powerful social
stigmas applied to shirkers.

Large numbers of people: It’s easier to
determine the shirkers in a small group and
the punishment is more profound when
people close to you shun you for not paying
your share.
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Illustrating Voluntary Contributions
to a Public Good: The Gulf War



Under the premise that defeating Iraq in the
Gulf War in 1990 was a public good to be
consumed by the industrialized economies
and Arab nations, each nation was expected
to contribute.
The U.S. and UK contributed the bulk of the
fighting forces.
Saudi Arabia, Kuwait, the UAE, Japan, and
Germany voluntarily paid $54 billion of the
estimated $61 billion cost.
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National Defense and Homeland
Security

National defense is a classic example of a public good.

Defense





From 1968 to 1978, defense spending fell from 9% of GDP to 5%.
Between 1978 and 1986, it increased to 6.3%.
By 1999, it had fallen to less than 4%.
In 2002, it was 4.5%.
Homeland Security
 The new department merged several agencies from the departments
of Justice, Transportation, Treasury, Agriculture, Energy, Health
and Human Services, and Commerce.

The Homeland Security Department could ultimately have 170,000
employees working in border and transportation security,
emergency preparedness and response, biological warfare defense,
and computer security. It will also house the Secret Service and
Coast Guard.
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