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 Heat Purely Private Purely Public Total consumed = sum Everyone feels the same of individual temp consumption Impossible for one to A market could form consume more heat and and people could adjust exclude the others their consumption Individuals will not be according to their able to adjust according preferences to their preferences Everyone Consumes the same amount
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Marginal Cost of allowing additional consumers to consume a public good Once a public good has been provided, what is the additional cost of allowing an additional person to enjoy the good?
Don’t confuse distribution with production Think of the marginal cost of allowing an additional person watch a fireworks display. Marginal Cost of Producing A Public Good
Let’s think production: Does the fact that a good is “public” alter how much it costs to produce another unit of the 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) 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 Price S=SMC of ice cream
$3
$2
D DJERRY BEN SMB =DBEN+JERRY
0 QJERRY QBEN QTOTAL Quantity of ice Notice cream 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 Price of missiles
$6
S=SMC $4 DJERRY
$3
$2$2 SMB=DBEN+JERRY DBEN $1
0 1 5 Quantity of missiles 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.
Quantity Alice Ben Carolyn Don You Try 1 1000 800 600 400 2 800 600 400 200 3 600 400 200 100 4 400 200 100 50 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? 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 Business Improvement Districts 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.