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Chapter 4 Public Goods 1 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. 2 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. 3 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. 4 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 5 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 6 Price Excludable Public Goods Price-excludable public good: there are external benefits when produced or consumed but exclusion is easy. Examples: Country Clubs, Cable TV 7 Congestible Public Goods 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 8 Marginal Cost Figure 4.2 A Congestible Public Good Marginal Cost per User 0 1 Number of Consumers per Hour 9 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 10 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. 11 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 12 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 13 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 14 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 15 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. 16 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). 17 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. 18 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. 19 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. 20