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Micro
McEachern
ECON
2008-2009
16
CHAPTER
Designed by
Amy McGuire, B-books, Ltd.
Chapter 16
Public Goods and
Public Choice
Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved
1
Private, Public Goods,
and in Between
LO1
Chapter 16
1. Private goods
– Rival in consumption
– Exclusive
– Provided by private
sector
2. Public goods
– Nonrival in
consumption
– Nonexclusive
– Provided by
government
Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved
2
Private, Public Goods,
and in Between
3. Natural monopoly
– Nonrival but exclusive
– With congestion:
private goods
– Provided by private
sector or government
4. Open-access good
– Rival but nonexclusive
– Regulated by
government
LO1
Chapter 16
Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved
3
LO1 Exhibit 1
Categories of Goods
Chapter 16
Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved
4
Optimal Provision of
Public Goods



Nonrival in consumption
– Once produced: available to all
consumers
Market demand curve
– Vertical sum of individual demand
curves
– Marginal benefit
Efficient level of public good
– Market D curve intersects MC curve
LO1
Chapter 16
Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved
5
LO1 Exhibit 2
Market for Public Goods
Because public goods, once
produced, are available to all in
identical amounts, the demand
for a public good is the vertical
sum of each individual’s demand.
The market demand for mosquito
spraying (D) is the vertical sum
of Maria’s demand, Dm, and
Alan’s demand, Da.
The efficient level :MC of mosquito spraying equals its marginal benefit; at
point e, where the marginal cost curve intersects the market demand curve.
Chapter 16
Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved
6
Paying for Public Goods

Tax = marginal valuation
– Free-rider problem
• People try to benefit from the public
goods without paying for them
– Ability to pay
LO1
Chapter 16
Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved
7
Public Choice in
Representative Democracy
 Public choices
– Government decisions
• Public goods
• Taxes
 Median-voter model
– The preference of the
median voter will
dominate other choices
LO2
Chapter 16
Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved
8
Special Interest and
Rational Ignorance
 Elected officials: Maximize
political support
– Special interest rather than
– Public interest
• Asymmetry
• Voters ‘rational
ignorance’
LO2
Chapter 16
Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved
9
Distribution of
Benefits and Costs
1. Widespread benefits; widespread costs
– Traditional public-goods legislation
– Positive impact on economy
• Total benefits > total costs
2. Concentrated benefits; widespread costs
– Special-interest legislation
– Harms the economy
• Total costs > total benefits
LO2 – Pork-barrel spending
Chapter 16
Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved
10
Distribution of
Benefits and Costs
3. Widespread benefits; concentrated costs
– Populist legislation
– Beneficiaries: rationally ignorant
4. Concentrated benefits; concentrated costs
– Competing-interest legislation
– Fierce political battles
LO2
Chapter 16
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11
LO2 Exhibit 3
Categories of Legislation Based on the
Distribution of Costs and Benefits
Chapter 16
Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved
12
Case Study
LO2 Farm Subsidies
Chapter 16
 The Agricultural Marketing Agreement Act, 1937
 Prevent ‘ruinous competition’
 One in four Americans: farm
 Floor prices
 2007
 One in fifty Americans: farm
 $18 billions a year
Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved
13
Case Study
LO2 Farm Subsidies
Chapter 16
 To subsidize farmers, consumers pay
 Higher product price
 For the surplus (taxpayers)
 For storage (the government buys
the surplus)
 E.g. milk
 Free market p=$1.50
 Subsidized
p=$2.50+$2.50+$0.50
 Farmers: normal profit
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14
LO2 Exhibit 4
Dollars per gallon
Effect of Milk Price Supports
Excess quantity supplied
$2.50
1.50
D
0
Chapter 16
75
100
150
No government intervention:
market price = $1.50 per gallon,
and 100 million gallons are sold
S per month.
Government: floor price = $2.50
per gallon, quantity supplied
increases and the quantity
demanded decreases.
To maintain the higher price, the
government must buy the excess
quantity at $2.50 per gallon.
Millions of gallons
per month
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15
Rent Seeking
 Activity interest groups undertake
– Secure special favors from government
 Political action committees
 Shift resources from production
 No incentive for economic efficiency
LO2
Chapter 16
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16
Case Study
LO2 Campaign Finance Reform
Chapter 16





Special-interest money
Soft money
Hard money
Money matters more to challengers
Efforts to limit campaign spending
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17
The Underground Economy
 Unreported market activity
– To avoid taxes
– Illegal
 Tax avoidance
– Legal
– Pay least possible tax
 Tax evasion
– Illegal
LO3 – No or fraudulent tax return
Chapter 16
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18
The Underground Economy
 Underground economy grows more
– Government regulation increase
– Tax rates increase
– Government corruption widespread
 Estimated: $1.4 trillion in 2007
LO3
Chapter 16
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19
Bureaucracy in
Representative Democracy
 Bureaus
– Government departments, agencies
 Ownership
– Taxpayers
 Funding
– Government appropriation
 Less incentive to eliminate waste and
inefficiency
LO4
Chapter 16
Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved
20
Bureaucracy in
Representative Democracy
 Bureaucratic objectives
– Serve the public
– Maximize budget
• Larger budget than desired by
median voter
LO4
Chapter 16
Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved
21
Bureaucracy in
Representative Democracy
 Private vs. public production
– Private production – may be more
efficient
– Public production – preferred by
public officials
LO4
Chapter 16
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22