Economics 4315/7315: Public Economics

Saku Aura

Department of Economics - University of Missouri

Economics 4315/7315: Public Economics 1 / 18 Public goods: pizza vs. national defense

Pizza Consumption rival Consumption excludable

National defense Consumption non rival Consumption non excludable

Economics 4315/7315: Public Economics 2 / 18 Consumption properties

Rival = once a particular unit of a good is consumed by someone it cannot be consumed by someone else Excludable = It is possible to exclude individuals from consuming a good (by charging a price, requiring a ticket, etc)

Economics 4315/7315: Public Economics 3 / 18 Public vs. private goods

Pure Public Good: non rival and non exludable Pure Private Good: Rival and excludable

Non-rivalness A special case of externality Analytics very similar to externality cases

Economics 4315/7315: Public Economics 4 / 18 Examples

High Excludability Low Excludability High Rivalry Food, Health Care, Local roads (non-toll) Pure private goods during rush hour

Low Rivalry Non crowded library Sunset, Defense

Economics 4315/7315: Public Economics 5 / 18 Variations of the theme

Low rivalry, high excludability: club good If the ”externality” or usefulness dies in geographical distance: local public good

Economics 4315/7315: Public Economics 6 / 18 Technology and public goods

Technology and the legal system are often used to make excludable goods out of fundamentally non-excludable goods

Examples TV broadcast (pure public good)-> scrambled tv broadcast (non-rival excludable good) DRM Protected CD (rival, excludable) –> DRM protected MP3 file (non-rival excludable) –> non DRM protected MP3 file (non-rival non-excludable)

Economics 4315/7315: Public Economics 7 / 18 Production vs. consumption

Who produces goods immaterial: consumption properties define the good classification Public goods produced by the private sector: Basic research in private universities Research funded by private foundations Search engines Public web content Commercial broadcast Open source software

Economics 4315/7315: Public Economics 8 / 18 Production vs. consumption continued

Private goods provided (at least partially) by the public sector: K12-education Health care Trash services Higher education

All of these have externality/public goods aspects, but they are primarily private goods

Economics 4315/7315: Public Economics 9 / 18 Excludability and for-profit provision

Without excludability no profits Market solutions to this: tie public good (web content, broadcast) to an excludable good (advertising) –> for-profit provision of public good

Economics 4315/7315: Public Economics 10 / 18 Efficiency with private goods

Two individuals Horizontal summation (efficiency=market equilibrium) Demand curve=Marginal Willingness to Pay

$

S=MC

D1+D2=Total Demand D2 D1

Q* Q

Economics 4315/7315: Public Economics 11 / 18 Efficient demand for public goods

Vertical summation of demand curves

$

S=MC

D1

D2 D1+D2=Total Demand

Q* Q

Economics 4315/7315: Public Economics 12 / 18 Efficient demand for public goods (continued)

Intuition:

Only one unit of marginal cost is used to produce marginal unit of public goods This unit is available for everyone –> Sum of willingness to pay relevant

Economics 4315/7315: Public Economics 13 / 18 Symmetry:

1 Private goods:

Price the same –> MRS the same for all individuals, quantity different

2 Public goods: Quantity the same for all –> MRS (price) different (Lindahl-Prices)

Economics 4315/7315: Public Economics 14 / 18 Mathematical example

Consumer 1: Q = 10 − P ⇒ P = 10 − Q Consumer 2: Q = 5 − P ⇒ P = 5 − Q Efficient demand  15 − 2Q, Q < 5 P = 10 − Q, 5 ≤ Q ≤ 10  0, Q > 10

Marginal cost MC = 3Q Efficiency Q = 3

Economics 4315/7315: Public Economics 15 / 18 Private provision of public goods:

Free rider problem In laboratory experiments and in real life: behavior more altruistic than simple model predicts In general: Free markets lead to underprovision compared to optimum

Economics 4315/7315: Public Economics 16 / 18 Crowd out from government expenditures?

In theory it is possible to have 100% crowd out –> $1 of government expenditure on public goods reduces private giving by $1 Empirically seems to be much smaller

Economics 4315/7315: Public Economics 17 / 18 Further reading

Diversifying your charitable giving and rationality Steven E. Landsburg, ”Giving Your All”, Slate. http://www.slate.com/id/2034/

Economics 4315/7315: Public Economics 18 / 18