Download The Art and Science of Economics

Chapter 16
Public Goods and Public
Choice
© 2006 Thomson/South-Western
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Introduction
Private goods have two important
features:
They are rival in consumption – the amount
consumed by one person is unavailable for
others to consume
They are exclusive – suppliers can easily
exclude those who don’t pay
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Public Goods
 Nonrival in consumption
 One
person’s consumption does not diminish the
amount available to others
 Once produced, public goods are available to all in
equal amount
 Marginal cost of providing the good to additional
consumers is zero
 Nonexclusive

Once a public good is produced, suppliers cannot easily
deny it to those who fail to pay  it is nonexclusive
 Because they are nonrival and nonexclusive, forprofit firms cannot profitably sell public goods
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Classification of Goods
Quasi-Public goods
When not congested are non rival
Producers can with relative ease exclude non payers
Open-access goods
 Rival
but nonexclusive
 Fish
in the ocean are rival in the sense that once caught
they are not available for others to catch
 Nonexclusive
in the sense that it would be costly or
impossible for a private firm to prevent access to
these goods
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Exhibit 1: Categories of Private and Public
Goods
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Optimal Provision of Public Goods
Suppose the public good in question is
mosquito control in a neighborhood, which, for
simplicity, consists of only two houses
One is headed by Alan and the other by Maria
Alan spends a lot of time in the yard, thus values a
mosquito-free environment more than does Maria
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Exhibit 2: Market for Public Goods
D
e
Dollars per hour
$15
Da
Marginal
cost
10
Dm
5
D
0
2
Hours of mosquito spraying
per week
Da and Dm are the
demand curves reflecting
the marginal benefits that
Alan and Maria,
respectively, enjoy at each
rate of output
How much mosquito
spraying should the
government provide?
Suppose the marginal
cost of spraying is a
constant $15 an hour; the
efficient level of output is 2
hours per week, where the
marginal benefit to the
neighborhood equals the
marginal cost
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Optimal Provision of Public Goods
Efficient approach would be to impose a tax
on each resident equal to marginal valuation
Once people realize their taxes are based on how much
the government thinks they value the good, people tend
to understate their true valuation
Taxpayers are reluctant to offer this information,
creating what is called the free-rider problem
Even if the government had accurate information
about marginal valuations, some households earn much
more than others  a greater ability to pay taxes
Taxing people according to their marginal valuations
may be efficient, but it may not be considered fair or
equitable
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Median-Voter Model
Voter whose preferences lie in the middle
of the set of all voters’ preferences
The median-voter model predicts that
under certain circumstances, the
preference of the median, or middle voter
will dominate other choices
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Special Interest and Rational Ignorance
Households have neither the time nor
the incentive to understand the effects
of public choices on every product
They realize that each of them has
only a tiny possibility of influencing
the outcome of public choices
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Special Interest and Rational Ignorance
Rational ignorance: voters remain
largely oblivious to the costs and
benefits of the thousands of proposals
considered by elected officials
The cost to the typical voter of
acquiring and acting on such
information is usually greater than
any expected benefits
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Distribution of Costs and Benefits
Traditional public-goods legislation
Widespread benefits and widespread costs
Usually has a positive impact on the economy
because total benefits exceed total costs
Special-interest legislation
Benefits are concentrated but costs widespread
across nearly all consumers and taxpayers
Generally harms the economy, on net, because total
costs often exceed total benefits
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Distribution of Costs and Benefits
Populist legislation
Widespread benefits but concentrated costs
Difficult time getting approved because the
widespread group that benefits typically remains
rationally ignorant of the proposed legislation 
voters provide little political support
Group adversely affected by costs will object
Competing-interest legislation
Involves both concentrated benefits and costs
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Exhibit 3: Categories of Legislation Based on
the Distribution of Costs and Benefits
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Exhibit 4: Effects of Milk Price Supports
If Congress
establishes a floor
price of $2.50 per
gallon, then the
quantity supplied
will increase and the
quantity demanded
will decrease
To maintain the
higher price, the
government must
buy the excess
quantity at $2.50
per gallon
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Rent Seeking
Rents: government transfer or subsidy
constitutes a payment to the resource
owner that exceeds the earnings
necessary to call forth that resource –
payment exceeding opportunity cost
The activity that interest groups
undertake to elicit these special favors
from government is called rent-seeking
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Rent Seeking
 Shifts resources from productive endeavors that
create output and income to activities that focus more
on transferring income to the special interest
 Do
nothing to increase output
 Frequently reduce output
Special interest groups compete for the same
government advantage, so more resources wasted
If the advantage conferred by government requires
higher income taxes, the net return individuals expect
from working and investing will fall and they may
work and invest less
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Underground Economy
It is reasonably accurate to say that when
government taxes productive activity, less
production gets reported
The underground economy is a term used
for all market activity that goes
unreported to the government either to
avoid taxes or because the activity itself is
illegal
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Underground Economy
A tax on productive activity has two effects:
 Resource
owners may supply less of the taxed
resource because the after-tax wage declines
To evade taxes, some people will shift from the
formal, reported economy to an underground,
“off-the-books” economy
avoidance is a legal attempt to arrange one’s
economic affairs so as to pay the least possible tax
 Tax evasion is illegal
 Tax
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Bureaucracy
Elected representatives approve
legislation
The task of implementing legislation is
typically left to bureaus
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Ownership and Funding of Bureaus
Bureaus are typically financed by budget
appropriation from the legislature, which
comes from taxpayers
Becomes of the differences in the forms of
ownership and in the sources of revenue,
bureaus have different incentives than do
for-profit firms so are likely to behave
differently
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Ownership and Behavior
Government bureaus receive less consumer
feedback and have less incentive to act on
any feedback they do receive
Government bureaus have less incentive to
act on the information available
Profits or losses arising in the bureau are
spread among all taxpayers, and because
there is no transferability of ownership,
bureaus have less incentive to satisfy
customers or to produce their output using
the least-cost combination of resources
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Bureaucratic Objectives
The legislature has only limited ability to dig into
the budget and cut particular items
If the legislature tries to cut the bureau’s budget,
the bureau will threaten to make those cuts as
painful to the legislature and constituents as
possible
Budget maximization results in a larger budget
than that desired by the median voter
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Private versus Public Production
Simply because some goods and services are
financed by the government does not mean that
they must be produced by the government
Elected officials may also use some combination
of bureaus and firms to produce the desired
output
The trend is toward increased privatization 
production by the private sector of government
provided goods and services
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Private versus Public Production
Legislators might prefer dealing with
bureaus rather than firms for two reasons
The internal organization of the bureau may
be more responsive to the legislature’s
concerns than the manager of a firm would
be
Bureaus provide legislators with
opportunities to reward friends and
supporters with government jobs
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