Download Econ 384 Chapter17c

 What is a Public Good?
 Efficient Provision of Public Goods
 The Efficiency Conditions
 Private Provision of Public Goods
 Free-Riders
 Privatization
A PURE PUBLIC GOOD has two features:
1) Nonrival – once provided, another person
can consume it at no additional cost
2) Nonexcludable (nonexclusive) – once
provided, it is impossible or highly
expensive to prevent anyone from
consuming it
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National Defense is a good example of a pure
public good:
1) Nonrival – all Canadians benefit
2) Nonexcludable – it’s impossible to prevent a
Canadian from benefitting
Other examples: Conventional Radio, A
Beautiful View, A Canada-Wide Sunglass
dome designed to block harmful sun rays
(Canadome)
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A PRIVATE GOOD has two features:
1) Rival – once consumed, another person
cannot consume it
2) Excludable (exclusive) – others can be
prevented from consuming it
Food (ie: pizza or sushi) is a good example of a
private good. Once I eat it, it’s gone.
(YUM!)
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6 Issues arise out of Pure Public Goods:
1) Different Values
2) Public Goods Aren’t Absolute
3) NONRIVAL ≠ NONEXCLUDABLE
4) Unconventional Public Good
5) Private Provision
6) Private Production
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-National defense protects everyone equally.
Paranoid people love it and peace activists
hate it.
-The Canadome is popular among people
concerned with cancer and unpopular with
people wanting tans. It affects everyone,
however
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-technology and the market can affect a public
good. A free TV station becomes private if
you need a decoder. A beautiful view
becomes rival if there is a crowd.
-An IMPURE PUBLIC GOOD is to some extent
rival or to some extent excludable
-most public goods are impure, but analysis of
pure public goods still gives valuable results
for impure public goods
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-National parks are excludable if they have
gates, but practically nonrival as they are so
big
-My office hours are nonexcludable, as
everyone is welcome, but rival if too many
people are waiting in line
-Therefore many public goods are impure public
goods
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-Inspiration can be nonrival and nonexcludable
(such as coming from a sunset)
-Fear is nonrival, as one person being afraid
doesn’t prevent others. Fear is also
nonexcludable, as its hard to prevent.
-Income distribution or honesty are public
goods as everyone benefits
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-Medical services, housing, licenses, and utilities
can all be provided by the government
and/or private sector
-The label public or private doesn’t indicate
what sector provides the item
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-Some public services are contracted out to
private contractors
-For example, the City of Edmonton contracts
out much of its snow removal business
-it provides the public service through
private contractors
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-To cover efficient provision of public goods, we
first look at efficient provision of private
goods
-Consider Maka and Susan’s individual demands
for video games
-At a market price, we add up Maka and Susan’s
quantity demanded for video games to find
market demand
-This results in a HORIZONTAL SUMMATION
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P
Maka
P
Susan
P
Market demand
100
40
2
Q
5
Q
7
Q
@ P=$40, QM+QS=QD
2+5=7
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When market supply intersects market demand, we
find equilibrium price and individual demand.
P
Maka
P
Susan
P
Market
S
100
65
40
2
1.5
Q
3.5 5
Q
Q*=5
7
Q
@ P*=$65, QM+QS=Q*
1.5+3.5=5
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-From microeconomic theory, we know that a
consumer maximizes utility where
MRSxy=Px/Py
-If we normalize Py to $1, this simplifies to
MRSxy=Px
-Since price is found on the demand curve,
Maka’s (Susan’s) demand expresses Maka’s
(Susan’s) MRS at each level of consumption
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-From microeconomic theory, the supply curve
comes from MC
-MRTxy=MCx/MCy, but since Py=MCy and Py=$1,
MRTxy=MCx
-therefore the supply curve represents MRTxy
Then, at equilibrium, Supply=Demand, and
MRTxy  MRS
PersonA
xy
 MRS
PersonB
xy
Pareto Efficiency Condition
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-Consider Maka and Susan’s individual demands
for a public good: youtube cooking shows
-youtube is nonrival and nonexcludable; one
person’s consumption doesn’t affect the
other
-The key difference in a public good is that
BOTH can consume a purchased good; it is
not used up
-This results in a VERTICAL SUMMATION to
calculate willingness to pay
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Market demand
P
Maka
Susan
P
10
P
11
7
4
2
Q
2
Q
2
Maka is willing to pay $4 each for 2 youtube
shows, and Susan is willing to pay $7 each,
therefore the market is willing to pay $11 each
Q
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Market demand
P
Maka
Susan
P
10
7
4
4
2
2 3
Q
P
11
S
6
2 3
Q
3
The market Supply gives an equilibrium quantity
of 3. Here price paid in the market ($6) is the sum
of Maka’s payment ($2) and Susan’s payment ($4).
Q
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-Once again, if we normalize our other good to
$1, demand (willingness to pay) represents
MRS for each person.
-The sum of both people’s willingness to pay
(market demand), is therefore the sum of
individual MRS.
-The supply curve still represents MC and
therefore MRT, so we have:
MRTxy  MRS
PersonA
xy
 MRS
PersonB
xy
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-Furthermore, again since Py=$1,
MC  MB
PersonA
 MB
PersonB
-Intuitively, public goods should therefore be
provided until the point where the marginal
cost of the good is equal to the sum of
marginal benefits
-The private good equation can also be
rewritten as
MC  MB
PersonA
 MB
PersonB
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In short, public goods are always best provided
where
Total Marginal Benefit = Marginal Cost
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1) Solve each demand for P
2) Find where P=0 to find cut-off points.
3) Add together applicable demand curves
between cut-off points.
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A) Equate S=D in multiple pieces of demand
function
-When solved Q* value lies in the
appropriate range, it is valid
B) Use individual demand to calculate each
person’s price (negatives are zero)
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Rick and Shane decide to buy some fireworks to
cheer up the survivors of the Zombie
apocalypse. Their demand curves and firework
supply are:
Q  100  P
D
R
Q  200  4 P
D
S
Q  P  20
S
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1)Q  100  P
2)Q  100  0
P  100  Q
Q  100
Q  200  4 P
Q  200  4(0)
P  50  Q / 4
Q  200
D
R
D
R
D
S
D
S
D
R
D
R
D
S
D
S
3)If Q  100
3)If Q  100
P D  PRD  PSD
P D  PSD
P D  100  Q  50  Q / 4
5
D
P  150  Q
4
P D  50  Q / 4
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3)
P
D

5
150 Q if Q 100
4
1
50 Q if Q 100
4
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If Q  100
P P
5
150  Q  20  Q
4
9
130  Q
4
9
130  Q
4
57.8  Q  Valid
D
S
If Q  100
PD  PS
1
50  Q  20  Q
4
5
30  Q
4
24  Q  Invalid
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2)P  100  Q *
2)P  50  Q * / 4
P  100  57.8
P  50  57.8 / 4
P  42.2
P  35.6
*
R
*
R
*
R
*
S
*
S
*
S
Rick will pay $42.20 and Shane will pay $35.60
for 57.8 fireworks….
Which attracts the zombies, who eat everyone…
Which is good for the zombies?
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Market demand
P
Shane
P
Rick
P
S
77.8
42.20
35.6
57.8
Q
57.8
Q
57.8
Q
Shane and Rick both put money towards the public
good, which everyone enjoys (until they’re eaten).
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If a public good is provided privately, its
efficiency depend on how people represent
their willingness to pay
-For private goods, people have no incentive to
misrepresent their willingness to pay
-if the price is $10, and that lies in their
willingness to pay, they will pay the $10,
consume the good and be happy
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-For public goods, people have an incentive to
misrepresent their willingness to pay
-if the price is $10, a person could hope
someone else pays the price, then they get
to enjoy it (they are a FREE RIDER)
-for example, at an alligator reserve, people can
pay money to throw meat into the water and
watch the alligators go, and often wait for
someone else to buy and throw the meat
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-If the public good can be made excludable (ie:
entrance fee), it is still provided inefficiently,
as the MC of an additional consumer is zero,
therefore P>MC
-The one way to avoid the free rider problem is
through PERFECT PRICE DISCRIMINATION –
everyone pays their willingness to pay
-this requires full information, therefore private
provision is often doomed to be inefficient
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THE FREE RIDER PROBLEM comes from the
incentive to let others pay while you enjoy
the benefits
-Yet empirically, people do band together to
raise funds for public goods such as libraries
-This typically only happens when the number
of contributors are small and everyone can
see their impact
-Therefore government intervention is often
needed for public goods
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The argument about who should PRODUCE
public goods (government or private) often
hinges on two concepts:
Cost
vs.
Quality
-private companies
often have lower costs
due to a focus on profit
and lack of unions
-private companies often
produce inferior
products (as in US health
insurance refusing
coverage or charging
high premiums)
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Some argue that quality can be maintained
through good contracts
-Some contracts are straightforward: cut the
park lawn once a week
-Some contracts are near impossible: treat
this yet-to-be-discovered disease with the
following yet-to-be-discovered drugs
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Market structure also needs to be considered:
-If the government has a monopoly, is lack of
competition causing inefficiency?
-If privatization creates a monopoly or oligopoly,
will market power cause inefficiency?
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West (1997) studied the 1993 privatization of
Alberta liquor stores and learned the
following:
-the number of liquor stores rose from 258 to
604, and although selection and individual
stores fell, overall selection increased
-liquor prices rose between 8.5% and 10%
(compared to 5% inflation)
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-Liquor store employment tripled as wages fell
by up to 50% (the union was replaced)
-There was no evidence of increased alcohol
consumption or alcohol-related crimes
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Was privatization good?
More stores vs. poorer selection
Liquor Price Increases
More employment vs. Lower wages
If this privatization is so complex, what does
that say about privatizing healthcare, utilities or
schools?
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 Externalities occur when one agents actions
affect another outside market mechanisms
 Externalities cause P≠SMC, causing
inefficiency
 Externalities can be dealt with privately
through:
1)Assigning property rights (Coase Theorem)
2)Mergers
3)Social Conventions
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 The government can deal with externalities
through:
1) Pigouvian Taxes
2) Pigouvian Subsidies
3) Permits and a market
4) Regulation
 Taxes and Permits are generally most
efficient and effective
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 All public methods to address negative
externalities suffer from:
1) the difficulty in measuring externalities
2) possible redistribution issues
 Positive externalities can be dealt with
through subsidies
 These can be hard to measure
 Financing subsidies can be distortionary
 This may effect equitable distribution
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 Public goods are nonrival and nonexcludable
 Public Goods are efficiently provided
where ∑MRS=MRT or ∑MB=MC
 (Private goods are efficiently provided
where MRSA = MRSB = MRT)
 Efficient provision occurs where
Total Benefit = Total cost
 It is unlikely that markets would provide
public goods efficiently, even if they are
excludable
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 Free-riding limits private provision of public
goods
 Two issues with production of public goods
are efficiency and quality
 Econ 384 had great students. Your professor
had a lot of fun teaching this course.
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