public goods

definition and examples

optimal provision
indivisibility and efficiency
non-excludability and efficiency
private provision vs. public provision
 public goods

– examples: national defense, radio broadcast

– 1st Welfare Theorem assumptions do not hold

• definition of a public good

• determining the socially optimal level of public good
• achieving and financing the socially optimal level of public
good
 public goods
definition

• non-rivalry/indivisibility
consumption by one agent does not reduce quantity available
for consumption by another

• non-excludability
if supplied, no consumer can be excluded
• impossibility of rejection
if supplied, it must be consumed
 public goods
definition

Is the good rival in consumption?

Yes No
Yes Private good Impure public good
Is the good (ice cream) (Cable TV)
excludable?
No Impure public good Public good
(crowded sidewalk) (defense)
 public goods
definition

rival non-rival

excludable private club

non-excludable common property public

resource
 public goods
optimal provision

Optimal Provision of Public Goods

How much of the public good should society provide?

•Markets will not provide the correct amount.
•To answer this question, start by reconsidering the
market for a private good, ice cream cones.
•Ben and Jerry have different tastes for ice cream (ic),
relative to the other good (c). How does the market
aggregate their preferences?
 public goods: optimal provision

Horizontal Summation in the Private Goods Market

Ben’s Marginal Jerry’s Marginal Market
Benefit Benefit
Price Price Price
of ice of ice of ice
cream cream cream
cone cone cone

S = SMC

$2 DB $2 DJ $2 E

DB&J = SMB

0 2 Quantity 0 1 Quantity 0 3 Quantity

of cones of cones of cones

• To find social demand curve, add quantity at each

price—sum horizontally.
 public goods: optimal provision
Vertical Summation in the Public Goods Market
Price of Ben’s marginal benefit
missiles
$2
1
DB
Price of0 1 5 Quantity of missiles
missiles
Jerry’s marginal benefit
$4

2
DJ
0 1 5 Quantity of missiles
Price of
missiles
$6
Social marginal benefit and cost
S = SMC

DB&J = SMB
0 1 5 Quantity of missiles
 public goods: optimal provision

Optimal Provision of Public Goods

Samuelson condition:
efficient level is such that Σi MRSi = MRT
public goods: indivisibility
efficiency
p

Mg Cost

DA+B

DB

DA

g* g
 public goods
indivisibility and efficiency

marginal cost
of congestion

N0 N
• optimal number of consumers?
if indivisible, N*=Nmax (no consumer should be excluded)

• optimal level of indivisible good?

Samuelson condition
 public goods: indivisibility and efficiency
discussion

• optimal number of agents implies no exclusion prices

• optimal level of public good requires information

• problem in perfect competition (uniform price) and in
monopolies with a large number of agents (no perfect price
discrimination, information)
• in a monopoly with a small number of consumers, information
cost is smaller – more feasible

• information also a problem for public provision

 public goods: non-excludability and efficiency
discussion

2
Contribute Don’t contribute

Contribute 1/4,1/4 -1/2, 1

Don’t contribute 1,-1/2 0,0

 public goods: non-excludability and efficiency
discussion

• Free-riding problem

• no alternative to public provision (with large numbers)

• private provision possible if small number of agents and
coordination is possible

• Clarke-Groves mechanisms
 public goods: non-excludability and efficiency
discussion

APPLICATION: The Free Rider Problem in Practice

The free rider problem is one of the most powerful

concepts in all of economics.
•Radio and television programming:
o WNYC has an estimated listening audience of
about 1 million people, but only 7.5% of their
listeners support the station.
o The United Kingdom uses a non-market solution:
The BBC charges an annual licensing fee to anyone
who owns and operates a TV!
 public goods: non-excludability and efficiency
discussion
APPLICATION: The Free Rider Problem in Practice
• File sharing:
o 85% of users of a file sharing program download
files only from others.
o The file-sharing software Kazaa gives download
priority to users according to their ratings, thus
discouraging free riders.
• Bicycle shares:
o Users were expected to return each bike riding.
o Within four days, not a single bicycle was left.
o Literal example of a “free ride.”
 public goods: non-excludability and efficiency
discussion
Can Private Provision Overcome the Free Rider Problem?
 public goods: non-excludability and efficiency
discussion
Altruism and social capital.
Private markets provide public goods when people are
altruistic.
•Altruistic: When individuals value the benefits and costs
to others in making their consumption choices.
•Many laboratory experiments provide evidence for
altruism and show that people contribute to public
goods.
•How altruistic people are is measured by social capital.
•Social capital: The value of altruistic and communal
behavior in society.
 public goods: non-excludability and efficiency
discussion
Warm Glow
People might simply feel good about contributing to
public goods or charity.
•Warm glow model: A model of the public goods
provision in which individuals care about both the total
amount of the public good and their particular
contributions as well.
•Different from altruism because people don’t care about
just the amount of the public good.
 public goods: non-excludability and efficiency
discussion
Public Provision of Public Goods
Despite private provision, there is a role for government
provision of public goods:
•Under private provision, not everyone contributes to the
good, even though everyone benefits.
•Government provision potentially solves the problem of
non-contributors.
•Nonetheless, there are several challenges to
government provision.
 public goods: non-excludability and efficiency
discussion
Public Provision: Measuring the Costs and Benefits
of Public Goods

Optimal public good provision requires knowing the MRS

for each person. How to measure this?
•Consider the case of a highway. Cost include wages and
materials.
• What if, without this highway project, half of the
workers on the project would be unemployed?
• How can the government take into account that it
is not only paying wages but also providing a new
job opportunity for these workers?
 public goods: non-excludability and efficiency
discussion

Public Provision: Measuring the Costs and Benefits

of Public Goods

The benefits of highway construction are also difficult to

measure.
• What is the value of the time saved for commuters
due to reduced traffic jams?
• And what is the value to society of the reduced
number of deaths if the highway is improved?
 public goods: non-excludability and efficiency
discussion
Public Provision: How Can We Measure
Preferences for the Public Good?
Three challenges in measuring preferences for public
goods.
1.Preference revelation: People may not want to reveal
their true valuation because the government might
charge them more for the good if they say that they value
it highly.
2.Preference knowledge: People may not know what
their valuation is.
3.Preference aggregation: How can the government
combine the preferences of millions of citizens?
 public goods: non-excludability and efficiency
discussion
Conclusion
• A major function of governments at all levels is the
provision of public goods.
• Sometimes, the private sector can provide public
goods, but usually not the optimal amount.
• Government intervention can potentially increase
efficiency.
• Success of intervention depends on:
o Ability of government to measure costs and
benefits
o Ability to implement optimal plan