ECON1210 Tutorial 9

Public Goods & Tragedy of Commons

TA: Julie Lu
Email: [email protected]

1
 Question from last chapter
Negative externalities
The relationship is as follows:
PMC + MEC = SMC

• Insisting on market solution leads to

welfare loss.
• When positive externalities exists, we
can impose a Pigouvian tax to increase
demand.

ECON1210 Tutorial 9 (Chapter 9: Public Goods & Tragedy of Commons) 2

 Question from last chapter
Positive externalities
The relationship is as follows:
PMB + MEB =SMB

• Insisting on market solution leads to

welfare loss.
• In case of positive externalities, we can
impose a Pigouvian subsidy to increase
demand.

ECON1210 Tutorial 9 (Chapter 9: Public Goods & Tragedy of Commons) 3

 Outline
1. Categorization of goods
2. Public goods offering
3. Common resources abusing

ECON1210 Tutorial 9 (Chapter 9: Public Goods & Tragedy of Commons) 4

 1. Categorization of goods
(1) Concept: Excludability
Excludable: A good is excludable if people who don’t pay can be easily prevented from using a
good
Non-excludable: A good is non-excludable if people who don’t pay cannot be easily prevented
from using a good

ECON1210 Tutorial 9 (Chapter 9: Public Goods & Tragedy of Commons) 5

 1. Categorization of goods
(2) Concept: Rivalry
Rival: A good is rival if one person’s use of a good reduces the ability of another person to use
the same good
Non-rival: A good is non-rival if one person’s use of a good does not reduce the ability of
another person to use the same good

ECON1210 Tutorial 9 (Chapter 9: Public Goods & Tragedy of Commons) 6

 1. Categorization of goods
(3) Four types of goods
Excludable Non-excludable
Rival Private goods Common resources
• No pay, no goods • No pay, still can obtain goods
• I use, you are less likely to use the • I use, you are less likely to use the same
same good good
Examples: Examples:
Jeans; Apples; Televisions; etc. Tuna in the ocean; Water; Coal; etc.
Nonrival Club goods Public goods
• No pay, no goods • No pay, still can obtain goods
• I use, you can use the same good, too • I use, you can use the same good, too
Examples: Examples:
Online music; W i-fi; Cable TV etc. Environmental protection; National defense;
Mosquito control; etc.

ECON1210 Tutorial 9 (Chapter 9: Public Goods & Tragedy of Commons) 7

 1. Categorization of goods
(3) Four types of goods: Reminder
A same good can be classified differently under different assupmtions
Example 1. Highway: (when there're only a few vehicles on the road) is non-rival
(when there's a traffic congestion on the road) is rival

ECON1210 Tutorial 9 (Chapter 9: Public Goods & Tragedy of Commons) 8

 Outline
1. Categorization of goods
2. Public goods offering
3. Common resources abusing

ECON1210 Tutorial 9 (Chapter 9: Public Goods & Tragedy of Commons) 9

 2. Public goods offering
(1) Whether to offer or not
Offer a public good —> the cost of offering is worth the total social
value? ——> wants to ensure that everyone reports their true value for
the good
Government
If one's payment for the good is related with his reported value, he will
under-report his value (free-rider);
If payments are not required, people who want the good to be offered
will over-report his value (incentivize the government)
Individual

A truth-telling mechanism that helps government decide whether to

Clarke-Groves Mechanism
offer the public goods.
ECON1210 Tutorial 9 (Chapter 9: Public Goods & Tragedy of Commons) 10
 2. Public goods offering
(1) Whether to offer or not
Example 1. Suppose the cost of offering a public good is $100 and the values of the residents
for the good is given as follows. Should the government offer the good? If yes, how much
should each resident pay?

Resident Value ($)

John 20
Smith 50
Patrick 60

ECON1210 Tutorial 9 (Chapter 9: Public Goods & Tragedy of Commons) 11

 2. Public goods offering
(1) Whether to offer or not
Example 1. Suppose the cost of offering a public good is $100 and the values of the residents
for the good is given as follows. Should the government offer the good? If yes, how much
should each resident pay?

Resident Value ($)

John 20
Smith 50
Patrick 60

Answer:
(i) $20+$50+$60>$100, offer the good

ECON1210 Tutorial 9 (Chapter 9: Public Goods & Tragedy of Commons) 12

 2. Public goods offering
(1) Whether to offer or not
Example 1.
Answer: (ii)
Under the Clarke-Groves Mechanism, each resident i needs to report his value vi for the good,
and conditional on offering, he needs to pay
pi = C−Σv−i
(Σv −i : sum of all other residents’ reported values)

We can thus write the payoff for resident i as

ui = vi − pi = vi − (C − Σv−i) = Σv − C,
which equals to the payoff to the whole society

ECON1210 Tutorial 9 (Chapter 9: Public Goods & Tragedy of Commons) 13

 2. Public goods offering
(1) Whether to offer or not
Example 1.
Answer: (ii)
Payoff for resident i equals to the payoff to the whole society equals to Σv − C
- If Σv − C > 0 and a resident under-reports his value, the public good may not be offered and
the resident’s payoff will reduce from a Σv − C to 0.
- If Σv − C < 0 and a resident over-reports his value, the public good may be offered and the
resident’s payoff will reduce from 0 to Σv−C.
Since the relation between the total valuation and total cost is unknown to everyone prior to the
final decision, reporting the truth thus becomes a dominant strategy for every resident.

ECON1210 Tutorial 9 (Chapter 9: Public Goods & Tragedy of Commons) 14

 2. Public goods offering
In-class Quiz 1: Go to Moodle page Inclass Exercises During Tutorials section

ECON1210 Tutorial 9 (Chapter 9: Public Goods & Tragedy of Commons) 15

 2. Public goods offering
In-class Quiz 1
The cost of the security device is $100.
Its value to Jones, who is poor, is $20.
Its value to Smith, who is rich, is $50.
Its value to Patrick, who is rich, is $60.
Consider the following policy:
1. Each report a valuation.
2. If the sum of the reported valuations are more than $100, security device is installed.
Under the VCG mechanism, the government will pay dollars for the security device.

A nswer: $20+$50+$60>$100

ECON1210 Tutorial 9 (Chapter 9: Public Goods & Tragedy of Commons) 16

 2. Public goods offering
In-class Quiz 1
The cost of the security device is $100.
Its value to Jones, who is poor, is $20. Its value to Smith, who is rich, is $50.
Its value to Patrick, who is rich, is $60.
2. If the sum of the reported valuations are more than $100, security device is installed.
Under the VCG mechanism, the government will pay dollars for the security device.

A nswer: According to the Clarke-Groves Mechanism,

Jones receives $10 (=$100-$50-$60), Smith pays $20 (=$100-$20-$60), Patrick pays $30
(=$100-$20-$5)
The rest of the cost is financed by government through other tax revenue, payment by the
government = C - (CJ + CS +CP) = $100 - [-$10 + $20 + $30] = $60

ECON1210 Tutorial 9 (Chapter 9: Public Goods & Tragedy of Commons) 17

 2. Public goods offering
(2) How much to offer

The government has decided to offer a public good,

but how much should it offer (quantity)?
=> (Suppose the MC of producing the good is given,)
the government considers the marginal benefit from
each additional unit of good

ECON1210 Tutorial 9 (Chapter 9: Public Goods & Tragedy of Commons) 18

 2. Public goods offering
(2) How much to offer
Recall that in Chapter 3, we want to explore how many private goods is demanded in the
market at a certain price
=> we use horizontal summation to draw the market demand curve for private goods

ECON1210 Tutorial 9 (Chapter 9: Public Goods & Tragedy of Commons) 19

 2. Public goods offering
(2) How much to offer
Here we want to explore how much more social benefit we can gain by providing an
additional unit of public good
=> we use the vertical summation to draw the social demand curve for public goods

ECON1210 Tutorial 9 (Chapter 9: Public Goods & Tragedy of Commons) 20

 Outline
1. Categorization of goods
2. Public goods offering
3. Common resources abusing

ECON1210 Tutorial 9 (Chapter 9: Public Goods & Tragedy of Commons) 21

 3. Common resources abusing
(1) Property of Common Resources
• Non-excludable: Without payment, you can get it.
• Rival: If I use it, you lose some ability to use it.

Everyone wants
Nonexcludable
to get it
Commons Tragedy

Everyone needs to
Rival
fight for it

ECON1210 Tutorial 9 (Chapter 9: Public Goods & Tragedy of Commons) 22

 3. Common resources abusing
(2) Tragedy of the Commons:
Definition: The Tragedy of the Commons is the tendency for any good which is unowned and
non-excludable to be overused and undermaintained.

ECON1210 Tutorial 9 (Chapter 9: Public Goods & Tragedy of Commons) 23

 3. Common resources abusing
(2) Tragedy of the Commons:
Example 2.
There are 10 residents living at the mid-level of a hill. The central business district is located at the foot
of the hill. Every morning, each resident can either drive or use free tram service down the hill to go to
work. As there is only a small road down the hill, traffic congestion may occur if many residents
choose to drive. If n residents choose to drive, it will take each resident 2n+1 minutes to drive down the
hill (n can only take integer values). On the other hand, it always takes 10 minutes to get down by tram.
Assume that other than driving time, all driving related costs are negligible.
(a) How many residents will drive in equilibrium if the residents make their decisions individually?
(b) If all residents have the same opportunity cost of time, what is the socially optimal number of
driving residents?

ECON1210 Tutorial 9 (Chapter 9: Public Goods & Tragedy of Commons) 24

 3. Common resources abusing
(2) Tragedy of the Commons:
Example 2. Compare MC from
Quantity (n) MC of driving MC of travelling by tram
(a) two activities
1 3=2*1+1 10 10-3=7>0
2 5=2*2+1 10 10-5=5>0
3 7=2*3+1 10 10-7=3>0
4 9=2*4+1 10 10-9=1>0
5 11=2*5+1 10 10-11=-1<0
6 13=2*6+1 10 10-13=-3<0
7 15=2*7+1 10 10-15=-5<0
8 17=2*8+1 10 10-17=-7<0
9 19=2*9+1 10 10-19=-9<0
10 21=2*10+1 10 10-21=-11<0
ECON1210 Tutorial 9 (Chapter 9: Public Goods & Tragedy of Commons) 25
 3. Common resources abusing
(2) Tragedy of the Commons:
Example 2.
Quantity (n) TC for Driving TC for travelling by tram Economic Surplus
(b)
1 3=1*3 10 10-3=7>0
2 10=2*5 20 20-10=10>0
3 21=3*7 30 30-21=9>0
4 36=4*9 40 40-36=4>0
5 55=5*11 50 50-55=-5<0
6 78=6*13 60 60-78=-18<0
7 105=7*15 70 70-105=-35<0
8 136=8*17 80 80-136=-56<0
9 171=9*19 90 90-171=-81<0
10 210=10*21 100 100-210=-110<0

ECON1210 Tutorial 9 (Chapter 9: Public Goods & Tragedy of Commons) 26

 3. Common resources abusing
(2) Tragedy of the Commons:
Example 2.
Compare (a) and (b), why there's a difference between two equilibriums?
The problem with private decisions is that no individual has any incentive to take into account
that an extra car on the road will take up the time and space that otherwise would have been
available to the cars already on the road.

ECON1210 Tutorial 9 (Chapter 9: Public Goods & Tragedy of Commons) 27

 3. Common resources abusing
(2) Tragedy of the Commons:
Example 2.
There are 10 residents living at the mid-level of a hill. The central business district is located
at the foot of the hill. Every morning, each resident can either drive or use free tram service
down the hill to go to work. As there is only a small road down the hill, traffic congestion may
occur if many residents choose to drive. If n residents choose to drive, it will take each
resident 2n+1 minutes to drive down the hill (n can only take integer values). On the other
hand, it always takes 10 minutes to get down by tram.
Assume that other than driving time, all driving related costs are negligible.

Possible solutions?

ECON1210 Tutorial 9 (Chapter 9: Public Goods & Tragedy of Commons) 28

3. Common resources abusing
(2) Tragedy of the Commons:
Example 2 Solution 1. Issue Licenses: We can limit the number of market players through licenses.
License price = X (3<X≤5)
Compare MC Compare MC
Quantity MC of MC of travelling by Quantity MC of MC of travelling by
from two from two
(n) driving tram (n) driving tram
activities activities
1 3=2*1+1 10 10-3=7>0 1 3 10 3+X<10
2 5=2*2+1 10 10-5=5>0 2 5 10 5+X≤10
3 7=2*3+1 10 10-7=3>0 3 7 10 7+X>10
4 9=2*4+1 10 10-9=1>0 4 9 10 9+X>10
5 11=2*5+1 10 10-11=-1<0 5 11 10 11+X>10
6 13=2*6+1 10 10-13=-3<0 6 13 10 13+X>10
7 15=2*7+1 10 10-15=-5<0 7 15 10 15+X>10
8 17=2*8+1 10 10-17=-7<0 8 17 10 17+X>10
9 19=2*9+1 10 10-19=-9<0 9 19 10 19+X>10
10 21=2*10+1 10 10-21=-11<0 10 21 10 21+X>10
29
previous After issuing licenses
 3. Common resources abusing
(2) Tragedy of the Commons:
Example 2 Solution 2. Impose a tax: raise the private cost to make it align with the social cost
There are 10 residents living at the mid-level of a hill. The central business district is located at the
foot of the hill. Every morning, each resident can either drive or use free tram service down the hill to
go to work. As there is only a small road down the hill, traffic congestion may occur if many
residents choose to drive. If n residents choose to drive, it will take each resident 2n+1 minutes to
drive down the hill (n can only take integer values). On the other hand, it always takes 10 minutes to
get down by tram.
Assume that other than driving time, all driving related costs are negligible.
(c) Suppose the opportunity cost of time is $5 per minute for every resident. If the government
charges a $20 toll for the road, how many residents will drive in equilibrium?

ECON1210 Tutorial 9 (Chapter 9: Public Goods & Tragedy of Commons) 30

3. Common resources abusing
(2) Tragedy of the Commons:
Example 2 Solution 2. Impose a tax: raise the private cost to make it align with the social cost
There are 10 residents living at the mid-level of a hill. The central business district is located at the
foot of the hill. Every morning, each resident can either drive or use free tram service down the hill
to go to work. As there is only a small road down the hill, traffic congestion may occur if many
residents choose to drive. If n residents choose to drive, it will take each resident 2n+1 minutes to
drive down the hill (n can only take integer values). On the other hand, it always takes 10 minutes
to get down by tram.
Assume that other than driving time, all driving related costs are negligible.
(c) Suppose the opportunity cost of time is $5 per minute for every resident. If the government
charges a $20 toll for the road, how many residents will drive in equilibrium?
[The tax is equivalent to 4 minutes] 31
3. Common resources abusing
(2) Tragedy of the Commons:
Example 2 Solution 2. Impose a tax: raise the private cost to make it align with the social cost
There are 10 residents living at the mid-level of a hill. The central business district is located at the
foot of the hill. Every morning, each resident can either drive or use free tram service down the hill
to go to work. As there is only a small road down the hill, traffic congestion may occur if many
residents choose to drive. If n residents choose to drive, it will take each resident 2n+1 minutes to
drive down the hill (n can only take integer values). On the other hand, it always takes 10 minutes
to get down by tram.
Assume that other than driving time, all driving related costs are negligible.
(c) Suppose the opportunity cost of time is $5 per minute for every resident. If the government
charges a $20 toll for the road, how many residents will drive in equilibrium?
2n + 1 + 4 ≥ 10, n=2 32
 2. Public goods offering
In-class Quiz 2: Go to Moodle page Inclass Exercises During Tutorials section

ECON1210 Tutorial 9 (Chapter 9: Public Goods & Tragedy of Commons) 33

 2. Public goods offering
In-class Quiz 2
There are 4 villagers in Utopia. Each of them can make money
either by making crafts or by fishing. A villager can make $1.8
per day from making crafts. The amount of fish in the nearby
No. of villagers Income per
lake is limited. The income each villager can earn from fishing Fishing villager (daily)
is decreasing in the number of villagers who choose to fish as 1 4

shown in the following table. 2 3

Suppose each villager chooses individually between fishing and 3 2

making crafts, ___ villagers will choose fishing. 4 1

When the total income of the village is maximized, ___

villagers choose fishing.

ECON1210 Tutorial 9 (Chapter 9: Public Goods & Tragedy of Commons) 34

 2. Public goods offering
In-class Quiz 2
Suppose each villager chooses individually between fishing and making crafts, 3 villagers will
choose fishing.

No. of villagers MB from fishing MB from crafts Compare MB

Fishing per villager (daily) per villager (daily) from two activities

1 4 1.8 4>1.8
2 3 1.8 3>1.8
3 2 1.8 2>1.8
4 1 1.8 1<1.8

ECON1210 Tutorial 9 (Chapter 9: Public Goods & Tragedy of Commons) 35

 2. Public goods offering
In-class Quiz 2
When the total income of the village is maximized, 2 villagers choose fishing.

No. of villagers Total Income Total Income Economics

Fishing through fish through crafts surplus

1 4=1*4 1.8 4-1.8=2.2

2 6=2*3 3.6 6-3.6=2.4
3 6=3*2 5.4 6-5.4=0.9
4 4=4*1 7.2 4-7.2=-3.2

ECON1210 Tutorial 9 (Chapter 9: Public Goods & Tragedy of Commons) 36

 Reminder
Quiz 9: Nov. 09, 10:30PM to Nov. 16, 10:30PM
Late Quiz 9: Nov. 16, 10:30PM to Nov. 18, 10:30PM

ECON1210 Tutorial 9 (Chapter 9: Public Goods & Tragedy of Commons) 37

 Acknowledgement
Materials of this tutorial are developed from the work of Dr. Ka-fu Wong, Mr. Mu
Haoxin, and Mr. Zhou Hongyi

ECON1210 Tutorial 9 (Chapter 9: Public Goods & Tragedy of Commons) 38