Lecture 4 Chapter 4
Public Goods
What we are going to do
◦ Definitions
◦ Examples
Rivalry – If someone consumes a good,
then no one else can
Excludability – If you don’t pay, you don’t
get the good.
Private Goods: Goods that are rival and
Excludable Result in no Externalities
Public Goods
Public Good
◦ you can’t stop people from consuming it
(nonexcludeable)
◦ Your consumption doesn’t affect other’s
consumption (nonrivalrous)
Public goods are associated with
externalities because no one has a
property right to a public good.
Public goods lead to free riding Benefiting from a good without paying for it.
Public Goods
Examples of Rivalry
◦ Is Satellite TV rivalrous?
No, it is nonrivalrous
◦ Is it Satellite TV exludable?
Yes, they can turn off your service
◦ Is it a public good then?
No, a good has to be both nonrivalrous and
nonexcludable.
Public Goods
Example of Excludability
◦ Is fishing international waters excludable?
No, who is going to enforce?
Think Whale Wars
◦ Is it rivalrous?
Yes, there are only so many fish in the ocean?
◦ Is it a public good?
No, because it is rivalrous
Public Good Examples
National Defense
◦ Rivalrous? Excludable?
◦ No. It is a public good because
it is nonrivalrous and
nonexcludable
Fireworks show
◦ Rivalrous? Excludable?
◦ No, it is a public good because
it is nonrivalrous and
nonexcludable
Public vs. Private
Bread
Purely Private
Total consumed = sum
of individual
consumption
A market could form
and people could adjust
their consumption
according to their
preferences
Heat
Purely Public
Everyone feels the same
temp
Impossible for one to
consume more heat and
exclude the others
Individuals will not be
able to adjust according
to their preferences
Everyone Consumes the
same amount
Table 1
Defining pure and impure public goods
Is the good rival in consumption?
Yes No
Is the good excludable?
Yes Ice cream Cable tv
No Crowded city sidewalk National defense
If a good is both rival and excludable,
it is a private good.
Ice cream is rival, because my
consumption of it precludes you from
consuming the same ice cream. The
only way for you to consume it is to
make more ice cream.
Ice cream is also excludable,
because I can simply not share my
ice cream with you.
Some goods are “impure” public
goods because they are non-rival,
but they are (to some extent)
excludable.
Cable TV is non-rival, because my
consumption of it in no way
diminishes your consumption.
It is excludable, since the cable
company can simply refuse to hook
up the system. Other goods are “impure” public
goods because they are rival, but not
excludable.
For example, a crowded sidewalk is
rival because your enjoyment is
reduced as more pedestrians also
use the same sidewalk.
Yet it is non-excludable because it is
clearly very difficult to prohibit
pedestrians from using the sidewalk.
Finally, pure public goods are both
non-rival and non-excludable.
National defense is a classic
example. It is non-rival because my
consumption of national defense
protection does not diminish your
consumption of it.
It is also non-excludable, because
once an area is protected, everyone
“consumes” that protection.
Marginal Cost of allowing additional
consumers to consume a public
good
Don’t confuse distribution with production
Think of the marginal cost of allowing an additional
person watch a fireworks display.
Once a public good has
been provided, what is
the additional cost of
allowing an additional
person to enjoy the
good?
Marginal Cost of Producing A Public
Good
Main Point: The marginal cost of producing a public good is
positive for each unit (the constant marginal cost curve is for
simplicity of explanation)
Let’s think production:
Does the fact that a good
is “public” alter how much
it costs to produce
another unit of the good?
Good Classification
Goods vary in their levels of excludability
and Rivalry
Provision of Public and Private
Goods What is the traditional way that we
believe private goods are provided to
consumers?
Public Goods?
What are examples of goods that are
both provided privately and by the
government?
◦ Tennis Courts, Education, Golf Courses
Congestible Public Goods Def: Goods for which crowding or
congestion reduces the benefits to
existing consumers when more
consumers are accommodated
◦ Marginal cost of accommodating an additional
consumer is not zero after the point of
congestion is reached
Example: a user of a congested road
decreases the benefits to existing users
by slowing traffic, increasing accident risk
Other Examples?
Congestible Public Goods
How do we graphically present a
congestible public good?
Price-Excludable Public Goods
Def: Goods with benefits that can be priced
Can be individually consumed and are subject
to exclusion, but their production and
consumption is likely to generate externalities
◦ Membership rights to private clubs
◦ Schools, hospitals, transportation
Is higher education a pure public good?
Why Does the Government fund Higher
Education then?
Annotated Bibliography
Def: An annotated bibliography is a list of citations to
books, articles, and documents. Each citation is followed
by a brief (usually about 150 words) descriptive and
evaluative paragraph, the annotation.
The purpose of the annotation is to inform the reader
of the relevance, accuracy, and quality of the sources
cited.
Alphabetical Order by last name of first author
Citation Style
Notes are what you need to write your paper
At least six total references, two from peer reviewed
journal articles
Due Date: October 20th
Where to find peer reviewed journal articles?
Market Demand for a Purely Private good
– Think Horizontal Each Individual chooses how much they want at each
price
Demand for a purely Private good is the horizontal
summation of the individual demand curves.
◦ Make sure demand is solved as Q a function of P, then
add. For Example Q= 20 – 2P
Quantity
of ice
cream
Price
of ice
cream
0 QBEN
SMB =DBEN+JERRY
QTOTAL
$2
S=SMC
$3
DBEN DJERRY
QJERRY
Notice
MBJerry = MBBen = MSC Efficiency
Demand for Pure Private Good
•Notice how the marginal conditions for
efficiency are met:
•MBA = MBB = MBC = MC
•Also notice that these are prices per loaf
Demand for Pure Public
Goods – Think Vertical
All consumers must
consume the same
quantity of the good
◦ Pure public goods cannot be
divided into individual units
Demand for public good
is the maximum
individuals are willing to
pay for the amount of the
good that is available
Demand for public good
is the vertical summation.
Think Price as a function
of quantity, P = 10 - .5Q
$2 $2
Quantity of
missiles
Price of
missiles
0
SMB=DBEN+JERRY
$4 S=SMC
$6
DBEN
DJERRY
1
$3
$1
5
Notice: the sum of the marginal benefits equal the
marginal social cost.
Demand for Pure Public Goods
For one Guard:
◦ Person A is willing to pay $300,
◦ person B $250
◦ person C $200
◦ Total for one guard
= $750
You Try
Bill’s demand for hamburgers (a private good) is
Q = 20- 2P and Ted’s demand is Q = 10 – P
1. Write down an equation for the social marginal
benefit of the consumption of the hamburger
2. Now suppose that hamburgers are a public
good. Write down an equation for the social
marginal benefit of hamburger consumption.
You Try
The table shows how the marginal benefit of a service varies for four
consumers.
a) Suppose the service is a pure private good and is sold in a competitive
market with only buyers being the four in the table. If the market price
of the product is $400, what is the quantity demanded?
b) Suppose the service is a pure public good. What is the marginal social
benefit of two units of service?
c) If the MSC of the good is $2,000 what is the efficient output assuming
that it is a pure private good?
d) If the MSC of the good is $2,000 what is the efficient output assuming
that it is a pure public good?
Quantity Alice Ben Carolyn Don
1 1000 800 600 400
2 800 600 400 200
3 600 400 200 100
4 400 200 100 50
Efficiency of a Pure Public Good
Review: The marginal social benefit of any
given amount of a pure public good is the
sum of the individual marginal benefits
received by all consumers.
Efficient quantity per time period
corresponds to the point at which output
is increased so that the sum of marginal
benefits to consumers equals marginal
social cost of the good.
Efficiency conditions are:
i
i
•From the perspective of Society
•Is one security guard efficient?
•Are two security guards
efficient?
•Are three security guards
efficient?
How to finance public goods
Lindhal Pricing: When each person pays an
amount equal to their marginal benefit.
◦ The government provides the public good and
finances its provision through each person
paying what it is worth to them
Examples
International View
◦ When Iraq invaded Kuwait in 1990, which countries were
at risk?
◦ Estimates of the cost of the war = $61 billion
◦ $54 billion came from other nations
$17 billion from Saudi Arabia
$16 billion from Kuwait
$11 billion from Japan
◦ US left with $7 billion of the incremental costs of fighting
the war.
How is this like a Lindahl equilibrium?
PROBLEM:
◦ If people know that they are required to pay a share of the cost of a
public good dependent on their marginal benefits, they have an
incentive to understate their true marginal benefits.
The Free Rider Problem
Def – A person who seeks to enjoy the benefits of a
public good without contributing anything to the cost of
financing.
This strategy almost guarantees that the equilibrium
amount of a pure public good will be less than the
efficient amount.
Problem becomes more acute in large groups where a
free rider reasons that their contribution is less likely to
be needed or missed
Our government provides lots of public goods, how do
they overcome the free rider problem?
ANS: Compulsory finance! Taxes!
Examples WNYC has an estimated listening audience of 1 million people,
but only 7.5% of their listeners support the station. In the United Kingdom, the BBC charges an annual licensing fee to anyone who owns and operates a TV.
A 2000 study of the file-sharing software Gnutella showed that 70% of users download files only from others. The file-sharing software Kazaa assigns users ratings based on their ratio of uploads to downloads and then gives download priority to users according to their ratings.
Cambridge, England, tried to provide 350 free green bicycles scattered throughout the city. Users were expected to return each bicycle to one of 15 stands after its use. Within four days, not a single bicycle could be found, most having been likely stolen and repainted.
In Lexington KY, the system worked better, 95% retention rate of bicycles
Examples
It is infeasible to charge pedestrians a fee for using the streets, so
cities use tax revenues to provide police, sanitation, and public
works departments. Public provision of these services does not
always work effectively.
Example: New York City’s Times Square
The city government spent ten years attempting to clean up Times Square.
A group of local businessmen decided to start a Business Improvement District (BID), a legal entity that privately provides local services, and funds these services with fees charged to local businesses.
New York law is structured so that if the BID organizers can get over 60% of the local business community to join, then the BID can (think of a law) levy fees on all local businesses.
Results:
Crime has dropped significantly.
The area is cleaner and more attractive.
Business and tourism are booming.
Business Improvement Districts