McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

CHAPTER 4

Public GoodsPublic Goods

4-2

Public Goods

“There exists an intrinsic connection between the common good on the hand and the structure and the function of public authority on the other.”

“The moral order, which needs public authority in order to promote the common good in human society, requires also that the authority be effective in attaining that end.” Pope John XXIII

4-3

Public Goods

Which goods and services should the public sector provide?

Which services that are currently provided by the government should be privatized?

These issues are in the heart of public policy and public finance.

4-4

Goods

Army Pizza Education Health Etc…

4-5

Public Goods

National Defense is an example of a pure public good, defined as fellows:

Once it is provided, the additional resource cost of another person consuming the good is zero – consumption is non-rival.

To prevent anyone from consuming the good is either very expensive or impossible – consumption is non-excludable.

4-6

Private Goods

In contrast private good like pizza is rival and excludable.

4-7

Characteristics of Goods

Excludable v Nonexcludable Excludable – preventing anyone from consuming the

good is relatively easy. Nonexcludable – preventing anyone from consuming the

good is either very expensive or impossible.

Rival v Nonrival Rival – once provided, the additional resource cost of

another person consuming the good is positive. Nonrival – once provided, the additional resource cost of

another person consuming the good is zero.

4-8

Types of Goods

EXCLUDABLE

RIVALYES NO

YES

NO

PRIVATE

GOODS

PUBLIC

GOODS

COMMON

RESOURCES

NATURALMONOPOLY

4-9

Noteworthy Aspects of Public Goods

Even though everyone consumes the same quantity of the good, it need not be valued equally by all.

Classification as a public good is not absolute; it depends on market conditions and the state of technology. impure public good

A commodity can satisfy one part of the definition of a public good but not the other.

Some things that are not conventionally thought of as commodities have public good characteristics.

Private goods are not necessarily provided exclusively by the private sector. publicly provided private goods

Public provision of a good does not necessarily mean that it is also produced by the public sector

4-10

Some Other Public Goods

Basic research Programs to fight poverty Uncongested nontoll roads Fireworks display

4-11

Efficient Provision

Efficient provision of public good requires that the sum of individual MRSs equal the MRT, unlike the private goods where each MRS equals the MRT.

Market mechanisms are unlikely to provide non-rival goods efficiently, even if they are excludable.

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Horizontal and Vertical Summation

Horizontal Summation: Finding the market demand at an given price involves summing the horizontal distance between each of the private demand curves and the vertical axis at the price.

For a public good, the group willingness to pay is found by the vertical summation of the individual demand curve.

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Efficient Provision of Private Goods

Price Adam (Df

A) Demand for Fig Leave

Eve (Df

A)Demand for Fig Leave

Market (Df

A+E)Horizontal Summation

$11 5 1 6

$9 7 3 10

$7 9 5 14

$5 11 7 18

$3 13 9 22

$1 15 11 26

4-14

0

1

2

3

4

5

6

7

8

9

10

11

12

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26

DfA

DfE

DfA+E

Sf

$

Quantity of Pizza

4-15

Pareto Efficiency – Private Goods Case

MRSfa = Pf/Pa

Set Pa = $1 MRSfa = Pf

DfA shows MRSfa for Adam

DfE shows MRSfa for Eve

Sf shows MRTfa

Necessary condition for Pareto efficiency: MRSfa

Adam = MRSfaEve = MRTfa

4-16

Efficient Provision of Public Goods

Units of Fireworks

1 2 3 4

Adam (DrA) $300 $250 $200 $150

Eve (DfE) 250 200 150 100

Market(Df

A+E)$550 $450 $350 $250

4-17

050100

150200250300350400

450500550600650

700750800

1 2 3 4

DrA

DrE

DrA+E

Sr

Quantity of Fireworks

$

4-18

Pareto Efficiency – Public Goods Case

MRSfa = Pf/Pa

Set Pa = $1 MRSfa = Pf

DfA shows MRSfa for Adam

DfE shows MRSfa for Eve

Sf shows MRTfa

Necessary condition for Pareto efficiency: MRSfa

Adam + MRSfaEve = MRTfa

4-19

Problems Achieving Efficiency

The Free-Rider Problem Solutions to the free-rider problem

Perfect price discrimination

Policy Perspective: Global Positioning System

Do people free ride?

Compare US and Palestine.

4-20

Laboratory Experiments and Free-Riding

How a typical experiment works Typical results

People contribute about 50% of resources to provision of public good

Contributions fall the more often the game is repeated Cooperation fostered by prior communication Contribution rates decline when opportunity cost of

giving goes up

“Warm-glow” giving

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The Privatization Debate

Public goods can be provided privately, and private goods can be provided publicly.

Even in cases where public provision of a good is selected, a choice between public and private production must be made.

4-22

The Privatization Debate

Privatization – taking services supplied by government and turning them over to the private sector.

Public v Private Provision: What is the right mix? Relative wage and materials costs Administrative costs Diversity of tastes

4-23

Distributional Issues

Commodity egalitarianism – notion that some commodities ought to be made available to everyone.

Example: Provision of Medical Care in USA. Example: Provision of Social Welfare in

Palestine.

4-24

Public versus Private Production

A key factor in determining whether public or private production depends on:

1. Efficiency of private production

2. Problems in comparing cost differences

3. Incomplete Contracts

4. Competition to supply good or service

5. Reputation building

6. Policy Perspective: Should airport security be produced publicly or privately?

7. Market Environment

4-25

Education: Public or Private?

Discussion.