ECON1210 Introductory Microeconomics

Tutorial 9
Topic 9: Public Goods & Tragedy of Commons

Tutor: Andy LAM

Email: [email protected]

Nov. 10, 2022

Agenda
• Review of Key Knowledge
ü Categorization of Goods
ü Public Goods
ü Common Recourses

• Reminders
Agenda
• Review of Key Knowledge
ü Categorization of Goods
ü Public Goods
ü Common Recourses

• Reminders
Review of Key Knowledge
Categorization of Goods: Nonexcludable; Nonrival

Nonexcludable Nonrival
A good is nonexcludable if people who don’t A good is nonrival if one person’s use of
pay cannot be easily prevented from using the good does not reduce the ability of
the good. another person to use the same good.

Nonexcludable è No payment, but can get. Nonrival è I use, you can use, too.

ECON1210 Tutorial 9 (Chapter 9: Public Goods / Commons)

Review of Key Knowledge
Categorization of Goods: 4 Categories of Goods

Excludable Nonexcludable
Private goods Common resources
• No pay, no goods • No pay, but goods
Rival • I use, you are less likely to get • I use, you are less likely to get
Examples: Examples:
Apples; Televisions; etc. Water; Coal; etc.

Club goods Public goods

• No pay, no goods • No pay, but goods
Nonrival • I use, you can use, too • I use, you can use, too
Examples: Examples:
Online music; Wi-fi (?); etc. National defense; Mosquito control; etc.

ECON1210 Tutorial 9 (Chapter 9: Public Goods / Commons)

Agenda
• Review of Key Knowledge
ü Categorization of Goods
ü Public Goods
p Basics
p Supply Side
p Demand Side

ü Common Recourses

• Reminders
Review of Key Knowledge
Public Goods: Basis for Discussion

Demand Side
Buying does not cost
Nonrival others’ chance. Hence,
[I use, you use] SMB>PMB. Therefore,
market quantity too little.

Public Government
Goods Decision

Nonexcludable Producers cannot charge.

[No payment] So, they do not produce.

Supply Side

ECON1210 Tutorial 9 (Chapter 9: Public Goods / Commons)

Review of Key Knowledge
Public Goods: Under-Provision and Free Rider Problem

Emergence of Free Rider Problem

Simply speaking, one thinks others will provide the public good and he/she can directly
share the benefit.
• This only happens to those who will produce the public goods if they are alone
instead of in a society.

ECON1210 Tutorial 9 (Chapter 9: Public Goods / Commons)

Review of Key Knowledge
Public Goods: Under-Provision and Free Rider Problem

Solution to Free Rider Problem (I): Tiebout Sorting (Textbook P8, Section 9.4)
Model assumptions:
• There are multiple jurisdictions providing different amount of public goods.
• People can move across jurisdictions.
Model Specification:
• n×𝑁 individuals in n districts.
• Each district can supply different amount of public goods, say 𝐺! , which is decided by voting.
• Assume that there are n heterogeneous groups requiring n different quantities of public goods.
Model Result:
• Individuals with the same quantity demanded move to the same district.
• Everyone is better off than choosing a common 𝐺.

ECON1210 Tutorial 9 (Chapter 9: Public Goods / Commons)

Review of Key Knowledge
Public Goods: Under-Provision and Free Rider Problem

Solution to Free Rider Problem (II): Donation (Textbook P9, Section 9.5)
Incentive for Donation:
• Emotional reward
• Recognition
• Externalities (Li Ka Shing set up a good entrepreneur image…)

ECON1210 Tutorial 9 (Chapter 9: Public Goods / Commons)

Agenda
• Review of Key Knowledge
ü Categorization of Goods
ü Public Goods
p Basics
p Supply Side
p Demand Side
u Total Willingness to Pay
u Vickrey-Clark-Groves
Mechanism
ü Common Recourses
• Reminders
Review of Key Knowledge
Public Goods: Demand Side

Difficulties for the Government to Observe the SMB

• Total willingness to pay needs the data from every individual.
• Individual reports of their individual willingness to pay can be fake.

ECON1210 Tutorial 9 (Chapter 9: Public Goods / Commons)

Review of Key Knowledge
Public Goods: Marginal Social Benefit

Total Willingness to Pay

• Only two persons in a society
• Willingness to pay given
• Public good

ECON1210 Tutorial 9 (Chapter 9: Public Goods / Commons)

Review of Key Knowledge
Public Goods: Marginal Social Benefit

Vertical Sum (Social Demand) Horizontal Sum (Market Demand)

Goods Public Goods Private Goods
Nonexcludable Excludable
Property
Nonrival Rival
No. Yes.
Horizontal? NR means that we can use the same. After I have bought, the unit of good
Reason Producing more than one will cost is mine. Others’ buy only
more. accumulates.
Yes. No.
Vertical? NR means that we can use the same. One can not benefit from the same
Reason Using the same unit benefits everyone unit bought by others. The marginal
together. benefit cannot be added up.

ECON1210 Tutorial 9 (Chapter 9: Public Goods / Commons)

Agenda
• Review of Key Knowledge
ü Categorization of Goods
ü Public Goods
p Basics
p Supply Side
p Demand Side
u Total Willingness to Pay
u Vickrey-Clark-Groves
Mechanism
ü Common Recourses
• Reminders
Review of Key Knowledge
Public Goods: Demand Side

Difficulties for the Government to Observe the SMB

• Total willingness to pay needs the data from every individual.
• Individual reports of their individual willingness to pay can be fake.

ECON1210 Tutorial 9 (Chapter 9: Public Goods / Commons)

Review of Key Knowledge
Public Goods: Vickrey-Clark-Groves Mechanism

Basic Settings of Clark-Groves Mechanism

• Purpose: Want everyone to tell the truth
• What can we, as the government, change?
p Cost of the public good?
p Individual’s valuation?
p Individual’s report?
p Individual’s payment?

ECON1210 Tutorial 9 (Chapter 9: Public Goods / Commons)

Review of Key Knowledge
Public Goods: Vickrey-Clark-Groves Mechanism

Basic Settings of Clark-Groves Mechanism

• Purpose: Want everyone to tell the truth
• What can we, as the government, change?
p Cost of the public good?
p Individual’s valuation?
p Individual’s report?
p Individual’s payment? Design a method of payment such that the individual will tell
the truth.

ECON1210 Tutorial 9 (Chapter 9: Public Goods / Commons)

Review of Key Knowledge
Public Goods: Vickrey-Clark-Groves Mechanism

How to induce truth-telling?

• If everyone tells the truth, then we can arrive at a social optimal outcome.
Only in this way can the government find the true social marginal benefit to make
provision decision.

ECON1210 Tutorial 9 (Chapter 9: Public Goods / Commons)

Review of Key Knowledge
Public Goods: Vickrey-Clark-Groves Mechanism

How to induce truth-telling?

Decision: Purpose:
Individual Whether or not to tell Maximizing individual
the truth economic surplus

Decision: Purpose:
Government How much to let an Maximizing social
individual pay economic surplus

ECON1210 Tutorial 9 (Chapter 9: Public Goods / Commons)

Review of Key Knowledge
Public Goods: Vickrey-Clark-Groves Mechanism

How to induce truth-telling?

Decision: Purpose:
Individual Whether or not to tell Maximizing individual
the truth economic surplus

Decision: Purpose:
Government How much to let an Maximizing social
individual pay economic surplus

ECON1210 Tutorial 9 (Chapter 9: Public Goods / Commons)

Review of Key Knowledge
Public Goods: Vickrey-Clark-Groves Mechanism

How to induce truth-telling?

Decision: Purpose:
Individual Whether or not to tell Maximizing individual
the truth economic surplus

Decision: Purpose:
Government How much to let an Maximizing social
individual pay economic surplus

ECON1210 Tutorial 9 (Chapter 9: Public Goods / Commons)

Review of Key Knowledge
Public Goods: Vickrey-Clark-Groves Mechanism

Set up the method

• If the welfare of each individual is aligned with the total social welfare, then there is no
incentive to lie.
• In this scenario, the social optimal solution will be also individually optimal.

ECON1210 Tutorial 9 (Chapter 9: Public Goods / Commons)

Review of Key Knowledge
Public Goods: Vickrey-Clark-Groves Mechanism

A parametric example
• Public good G. Cost of G = 𝐶.
• Three persons in the society: Amy, Bob and Cindy.
Amy’s valuation (willingness to pay) = 𝑥
Bob’s valuation (willingness to pay) = 𝑦
Cindy’s valuation (willingness to pay) = 𝑧
• Government want to decide 𝐶! , 𝐶" , and 𝐶# .

ECON1210 Tutorial 9 (Chapter 9: Public Goods / Commons)

Review of Key Knowledge
Public Goods: Vickrey-Clark-Groves Mechanism

A parametric example
• Total social welfare = 𝑥 + 𝑦 + 𝑧 − 𝐶
• Amy’s total welfare = 𝑥 − 𝐶!
• Bob’s total welfare = 𝑦 − 𝐶"
• Cindy’s total welfare = z − 𝐶#
• Only information for the government is reported prices: 𝑅! , 𝑅" , and 𝑅# .
• Relate 𝐶! , 𝐶" , and 𝐶# with 𝑅! , 𝑅" , and 𝑅# .

ECON1210 Tutorial 9 (Chapter 9: Public Goods / Commons)

Review of Key Knowledge
Public Goods: Vickrey-Clark-Groves Mechanism

A parametric example
• If the welfare of each individual is aligned with the total social welfare, then there is no
incentive to lie.
• Let 𝑥 − 𝐶! = 𝑥 + 𝑦 + 𝑧 − 𝐶. We have 𝐶! = 𝐶 − (𝑦 + 𝑧).
• Since in this scenario, everyone will tell the truth, 𝑅! = 𝑥, 𝑅" = 𝑦, and 𝑅# = 𝑧.
• Method: Set one’s payment to be [𝑪 − 𝒔𝒖𝒎 𝒐𝒇 𝒐𝒕𝒉𝒆𝒓𝒔’ 𝒓𝒆𝒑𝒐𝒓𝒕𝒆𝒅 𝒑𝒓𝒊𝒄𝒆𝒔].

ECON1210 Tutorial 9 (Chapter 9: Public Goods / Commons)

Review of Key Knowledge
Public Goods: Vickrey-Clark-Groves Mechanism

Verification
• If 𝑥 < 𝐶 − (𝑅" + 𝑅# ), then Amy does not want the production of G.
• This is equivalent to 𝑥 + (𝑅" + 𝑅# ) < 𝐶, giving the same social decision as Amy’s.
• If 𝑥 > 𝐶 − (𝑅" + 𝑅# ), then Amy wants the production of G.
• This is equivalent to 𝑥 + 𝑅" + 𝑅# > 𝐶, giving the same social decision as Amy’s.

• Same analysis for Bob and Cindy. Hence, everyone has no incentive to lie, since private
decision is aligned with the social decision.

ECON1210 Tutorial 9 (Chapter 9: Public Goods / Commons)

Review of Key Knowledge
Public Goods: Vickrey-Clark-Groves Mechanism

Analysis
• 𝐶$ , should not be directly related to 𝑅$ . Otherwise, there is always incentive to lie.
• Hence, 𝐶$ , should only be related to 𝑅% directly, where 𝑗 ≠ 𝑖.
• However, is 𝐶$ related to 𝑅$ ? Yes. Since 𝑅$ ’s change will affect the production decision,
hence 𝐶$ .

• Government payment = C − (𝐶! + 𝐶" + 𝐶# )

ECON1210 Tutorial 9 (Chapter 9: Public Goods / Commons)

Agenda
• Review of Key Knowledge
ü Categorization of Goods
ü Public Goods
ü Common Recourses
p Source of the Tragedy
p Tragedy of the Commons
p Solutions and Mitigations

• Reminders
Review of Key Knowledge
Source of the Tragedy

Property of Common Resources

• Nonexcludable: Without payment, you can get it.
• Rival: If I use it, then you lose some ability to get it.

ECON1210 Tutorial 9 (Chapter 9: Public Goods / Commons)

Review of Key Knowledge
Source of the Tragedy

Property of Common Resources

• Nonexcludable: Without payment, you can get it.
• Rival: If I use it, then you lose some ability to get it.

Nonexcludable
Everyone wants to get it!!!
[No payment]

Commons Tragedy

Rival Everyone needs to fight

[I use, you can’t] for it!!!

ECON1210 Tutorial 9 (Chapter 9: Public Goods / Commons)

Agenda
• Review of Key Knowledge
ü Categorization of Goods
ü Public Goods
ü Common Recourses
p Source of the Tragedy
p Tragedy of the Commons
p Solutions and Mitigations

• Reminders
Review of Key Knowledge
Tragedy of the Commons: Definition

Definition
The Tragedy of the Commons is the tendency for any good which is unowned and
nonexcludable to be overused and undermaintained.
• Unowned: Unowned for rival
• Nonexcludable: Nonexcludable so that the demand is infinitely large

ECON1210 Tutorial 9 (Chapter 9: Public Goods / Commons)

Review of Key Knowledge
Tragedy of the Commons: Example

Example: AQ1(a)(b) (2018 Final)

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 / Commons)

Review of Key Knowledge
Tragedy of the Commons: Example

Example: AQ1(a)(b) (2018 Final)

(a) Individual Quantity (n) MC of driving MC of tram “MB”=MC
1 3 10 10-3=7>0
2 5 10 10-5=5>0
3 7 10 10-7=3>0
4 9 10 10-9=1>0
5 11 10 10-11=-1<0
6 13 10 10-13=-3<0
7 15 10 10-15=-5<0
8 17 10 10-17=-7<0
9 19 10 10-19=-9<0
10 21 10 10-21=-11<0
ECON1210 Tutorial 9 (Chapter 9: Public Goods / Commons)
Review of Key Knowledge
Tragedy of the Commons: Example

Example: AQ1(a)(b) (2018 Final)

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?
2𝑛 + 1 = 10 ⇒ 𝑛 = 4.5

ECON1210 Tutorial 9 (Chapter 9: Public Goods / Commons)

Review of Key Knowledge
Tragedy of the Commons: Example

Example: AQ1(a)(b) (2018 Final)

(b) Social Quantity (n) Driving TC MC of tram Econ Surplus
1 3 10 10-3=7>0
2 10 20 20-10=10>0
3 21 30 30-21=9>0
4 36 40 40-36=4>0
5 55 50 50-55=-5<0
6 78 60 60-78=-18<0
7 105 70 70-105=-35<0
8 136 80 80-136=-56<0
9 171 90 90-171=-81<0
10 210 100 100-210=-110<0
ECON1210 Tutorial 9 (Chapter 9: Public Goods / Commons)
Review of Key Knowledge
Tragedy of the Commons: Example

Example: AQ1(a)(b) (2018 Final)

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.
(b) If all residents have the same opportunity cost of time, what is the socially optimal number of driving
residents?
2𝑛 + 1 𝑛 + 10 10 − 𝑛 = 2𝑛" − 9𝑛 + 100 = 2 𝑛 – 2.25 " + 89.875 ⇒ 𝑛 = 2

ECON1210 Tutorial 9 (Chapter 9: Public Goods / Commons)

Agenda
• Review of Key Knowledge
ü Categorization of Goods
ü Public Goods
ü Common Recourses
p Source of the Tragedy
p Tragedy of the Commons
p Solutions and Mitigations

• Reminders
Review of Key Knowledge
Solutions and Mitigation: License

Issue Licenses: We can limit the number of market players through licenses.
Quantity (n) MC of driving MC of tram “MB”=MC
1 3 10 3+X<10
License price = X 2 5 10 5+X<=10
𝟑<𝑿≤𝟓 3 7 10 7+X>10
4 9 10 9+X>10
5 11 10 11+X>10
6 13 10 13+X>10
7 15 10 15+X>10
8 17 10 17+X>10
9 19 10 19+X>10
10 21 10 21+X>10
ECON1210 Tutorial 9 (Chapter 9: Public Goods / Commons)
Review of Key Knowledge
Solutions and Mitigation: Quota

Quota limit: We can limit the number of goods consumed through quota.

ECON1210 Tutorial 9 (Chapter 9: Public Goods / Commons)

Review of Key Knowledge
Solutions and Mitigation: Price Manipulation

Tax or subsidy?
Tax: Raise the private cost è Align with the social cost
Subsidy: Raise the private benefit è Consume more (NO!)

ECON1210 Tutorial 9 (Chapter 9: Public Goods / Commons)

Review of Key Knowledge
Solutions and Mitigation: Price Manipulation

Tax: AQ1(c) (2018 Final)

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 / Commons)

Review of Key Knowledge
Solutions and Mitigation: Price Manipulation

Tax: AQ1(c) (2018 Final)

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?
[A tax equivalent to 4 minutes.]

ECON1210 Tutorial 9 (Chapter 9: Public Goods / Commons)

Review of Key Knowledge
Solutions and Mitigation: Price Manipulation

Tax: AQ1(c) (2018 Final)

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

ECON1210 Tutorial 9 (Chapter 9: Public Goods / Commons)

Agenda
• Review of Key Knowledge
ü Categorization of Goods
ü Public Goods
ü Common Recourses

• Reminders
Reminders
Quiz Due Date

Regular Quiz 9 Due on Nov. 16 (Wed.)

ECON1210 Tutorial 9 (Chapter 9: Public Goods / Commons)