When you have completed your study of this chapter, you will be able to

C H A P T E R C H E C K L I S T

Distinguish among private goods, public goods, and common resources.

1

Explain the free-rider problem and how public provision can help to overcome that problem.

2

Explain the problem of the commons and review the possible solutions to that problem.

3

10.1 CLASSIFYING GOODS AND RESOURCES

What is the essential difference between:• A city police department and Brinks security• Fish in the Atlantic Ocean and fish in a fish farm• A live concert and a concert on television

These, and all goods and services can be classified according to whether they are excludable or nonexcludable and rival or nonrival.

Excludable

Excludable

A good, service, or resource is excludable if it is possible to prevent a person from enjoying its benefits.

Nonexcludable

A good, service, or resource is nonexcludable if it is impossible to prevent a person from enjoying its benefits.

10.1 CLASSIFYING GOODS AND RESOURCES

Examples of excludable items are:• The services of Brinks security• Fish in a fish farm• A live concert

Examples of nonexcludable items are:• The services of the city police department• Fish in the Atlantic Ocean• A broadcast television signal

10.1 CLASSIFYING GOODS AND RESOURCES

10.1 CLASSIFYING GOODS AND RESOURCES

Rival

Rival

A good, service, or resource is rival if its consumption by one person decreases its consumption by other people.

Nonrival

A good, service, or resource is nonrival if its consumption by one person does not decrease its consumption by other people.

Examples of rival items are:• The services of Brinks security• Fish both in ocean and in a fish farm• A seat at a live concert

Examples of nonrival items are:• The protection provided by a city police

department• A broadcast television signal

10.1 CLASSIFYING GOODS AND RESOURCES

10.1 CLASSIFYING GOODS AND RESOURCES

Private good

A good or service that can be consumed by only one person at a time and only by those people who have bought it or own it.

Public good

A good or service that can be consumed simultaneously by everyone and from which no one can be excluded.

A Four-Fold Classification

10.1 CLASSIFYING GOODS AND RESOURCES

Common resource

A resource that is nonexcludable and rival—can be used only once but no one can be prevented from using what is available.

Natural monopoly

A good or service that is nonrival but excludable—can be produced at zero marginal cost.

A Four-Fold Classification

Figure 10.1 shows this four-fold classification of goods and services.

10.1 CLASSIFYING GOODS AND RESOURCES

Public goods create a free-rider problem.

Free rider

A person who enjoys the benefits of a good or service without paying for it.

Because of the free-rider problem, the market would provide too small a quantity of a public good.

To produce the efficient quantity, government action is required.

10.1 PUBLIC GOODS10.2 PUBLIC GOODS AND FREE RIDER PROBLEM

The Free-Rider Problem

The benefit a public good provides is the value of its services.

Because satellite services are nonrival and nonexcludable, they are a public good.

• Everyone consumes the same quantity of them.

To find the economy wide value of the satellites, we add together the marginal benefits of everyone in the economy.

The Marginal Benefit of a Public Good

10.2 PUBLIC GOODS AND FREE RIDER PROBLEM

Figure 10.2 shows how to find an economy’s MB curve.

Lisa’s marginal benefit curve is MBL.

The MB curve for the economy is the vertical sum of the marginal benefit curves of everyone in the economy.

Max’s marginal benefit curve is MBM.

10.2 PUBLIC GOODS AND FREE RIDER PROBLEM

Marginal cost increases as the quantity of satellites produced increases—the principle of increasing marginal cost.

So the marginal cost curve of satellites slopes upward.

The Marginal Cost of a Public Good

10.2 PUBLIC GOODS AND FREE RIDER PROBLEM

The Efficient Quantity of a Public Good

Resources are used efficiently if marginal benefit equals marginal cost.

If marginal benefit exceeds marginal cost, resources can be used more efficiently by increasing the quantity produced.

If marginal cost exceeds marginal benefit, resources can be used more efficiently by decreasing the quantity produced.

10.2 PUBLIC GOODS AND FREE RIDER PROBLEM

Figure 10.3 shows the efficient quantity of a public good.

1. If MB exceeds MC, an increase in the quantity will make resource use more efficient.

2. If MC exceeds MB, a decrease in the quantity will make resource use more efficient.

10.2 PUBLIC GOODS AND FREE RIDER PROBLEM

3. If MB equals MC, resource use is efficient.

4. The efficient quantity is 200 satellites.

10.2 PUBLIC GOODS AND FREE RIDER PROBLEM

No one would have an incentive to buy his or her share of the satellite system—the free-rider problem.

So a private firm would not supply satellites.

Private Provision

The political process determines the quantity of a public good provided.

Public Provision

10.2 PUBLIC GOODS AND FREE RIDER PROBLEM

Figure 10.4(a) shows the preferences of two political parties in an election.

1. Doves would like to provide 100 satellites.

2. The Hawks would like to provide 300 satellites.

10.2 PUBLIC GOODS AND FREE RIDER PROBLEM

Figure 10.4(b) shows an efficient political outcome.

3. The political outcome is 200 satellites because, unless each party proposes 200 satellites, the other party can beat it in the election.

10.2 PUBLIC GOODS AND FREE RIDER PROBLEM

Principle of minimum differentiation

The tendency for competitors to make themselves identical to appeal to the maximum number of clients or voters.

Principle of Minimum Differentiation

10.2 PUBLIC GOODS AND FREE RIDER PROBLEM

Bureaucrats translate the choices of politicians into programs and control the day-to-day activities that deliver public goods.

The behavior of bureaucrats modifies the political outcome.

Rational Ignorance

The decision not to acquire information because the marginal cost of doing so exceeds the expected marginal benefit.

The Role of Bureaucrats

10.2 PUBLIC GOODS AND FREE RIDER PROBLEM

Government grows in part because the demand for some public goods increases at a faster rate than the demand for private goods.

Two possible reasons are:• Voter preferences• Inefficient overprovision

Why Government Is Large and Grows

10.2 PUBLIC GOODS AND FREE RIDER PROBLEM

Voter Preferences

As voters’ incomes increase, the demand for many public goods increases more quickly than income. These goods include:

• Highways; air-traffic control systems; public health; education; and national defense.

Inefficient Overprovision• The goal of budget maximization combined with

voters’ rational ignorance might explain the expanding government budgets.

10.2 PUBLIC GOODS AND FREE RIDER PROBLEM

A backlash against government programs might force politicians of all parties to embrace smaller and leaner government.

Privatization of the production of public goods might also counter the tendency for government budgets to grow.

Voter Backlash

10.2 PUBLIC GOODS AND FREE RIDER PROBLEM

10.3 COMMON RESOURCES

The Problem of the Commons

The problem of the commons is the absence of incentives to prevent the overuse and depletion of a commonly owned resource.

Examples include the Atlantic Ocean cod stocks, South Pacific whales, and the quality of the earth’s atmosphere.

The traditional example from which the term derives is the common grazing land surrounding middle-age villages.

10.3 COMMON RESOURCES

Figure 10.5 illustrates production possibilities from a common resource.

As the number of fishing boats increases, the quantity of fish caught increases to some maximum.

Beyond that maximum, the sustainable catch decreases.

10.3 COMMON RESOURCES

Figure 10.6 shows why a common resource get overused.

1. The average catch per boat, which is the marginal private benefit, MPB, decreases as the number of boats increases.

2. The marginal cost per boat is MC (assumed constant).

10.3 COMMON RESOURCES

3. Equilibrium occurs where marginal private benefit, MPB, equals marginal cost, MC.

In equilibrium, the resource is overused because no one takes into account the effects of her/his actions on other users of the resources.

10.3 COMMON RESOURCES

The Efficient Use of the Commons

The quantity of fish caught by each boat decreases as the number of boats increases.

But no one has an incentive to take this fact into account when deciding whether to fish.

The efficient use of a common resource requires marginal cost to equal marginal social benefit.

10.3 COMMON RESOURCES

Marginal Social Benefit

Marginal social benefit is the increase in total fish catch that results from an additional boat, not the average catch per boat.

Table 10.1 on the next slide shows the calculation of marginal social benefit.

10.3 COMMON RESOURCES

Boats Total Catch MSB

A 0 0

90

B 1 90

70

C 2 160

50

D 3 210

30

E 4 240

10.3 COMMON RESOURCES

Efficient Use

Figure 10.7 illustrates the efficient use of a common resource.

1. The marginal social benefit curve, MSB, is below the MPB curve.

2. The resource is used efficiently when MSB equals MC.

10.3 COMMON RESOURCES

Achieving an Efficient Outcome

It is harder to achieve an efficient use of a common resource than to define the conditions under which it occurs.

Three methods in use are:• Property rights• Quotas• Individual transferable quotas (ITQs)

10.3 COMMON RESOURCES

Property Rights

By assigning property rights, common property becomes private property.

When someone owns a resource, the owner is confronted with the full consequences of her/his actions in using that resources.

The social benefits become the private benefits.

10.3 COMMON RESOURCES

In Figure 10.7, the marginal social benefit curve, MSB, becomes the marginal private benefit curve.

The resource is used efficiently because the owner of the resources is best off when MSB equals MC.

10.3 COMMON RESOURCES

Quotas

By assigning setting a production quota at the efficient quantity, a common resource might remain in common use but be used efficiently.

Figure 10.8(a) shows this situation.

It is hard to make a quota work.

10.3 COMMON RESOURCES

Individual Transferable Quotas

An individual transferable quota (ITQ) is a production limit that is assigned to an individual who is free to transfer the quota to someone else.

A market emerges in ITQs.

If the efficient quantity of ITQs is assigned, the market price of a quota confronts resource users with a marginal cost that equals MSB at the efficient quantity.

10.3 COMMON RESOURCES

Figure 10.8(b) shows the situation with an efficient number of ITQs.

Marginal cost rises from MC0 to MC1.

Users of the resource make marginal private benefit, MPB, equal to marginal private cost, MC1,

and the outcome is efficient.