Yuh Huei Jang

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18.e. Public Goods

Generally, public goods are considered goods that benefit all consumers, such as a city
park. However, in the view of economists, public goods need not be provided by the
government. A public good need only meet two criteria: that it is nonrival consumption,
and that there is nonexclusion.

Nonrival Consumption
Given a certain level of production, a good can be considered nonrival in consumption if
one’s consumption of that good does not affect the quantity consumed by other
individuals. All individuals that receive this good benefit from it simultaneously. An
example that can be used is that of a crime watch program. One resident of a community
is able to benefit from a lower level of crime, as other also do simultaneously.
Conversely, a good that is rival in consumption diminishes another’s use of that good if
an individual benefits from it. Simultaneous consumption of a good is not possible if a
good is rival in consumption. There include the typical goods that may come to mind,
such as televisions, clothing, and food.

Nonexclusion
A condition that is characterizes nonexclusion can be thought of one in which a good’s
benefits may be not confined (or be prohibitively costly to do so) once produced.
National defense is one example of a good that cannot be excluded. All residents of a
country are protected by the service of defense that is produced—regardless of whether
they are a citizen or not. An example of a exclusive good might be public access content
that requires a certain user identification and password for designated areas. The general
information is very accessible to all, but access to more sensitive content may be limited
to law enforcement agencies with the proper authentication.

The Free-Rider Problem

With these two conditions—nonrival consumption and nonexclusion (thus making a

public good)—in play, we can begin to set the foundations for our next topic. A nonrival
nonexclusive good shakes up the market system. No private firm would have incentive
to pursue production of such a good because it would be possible for those who do not
pay for it to benefit from it.

This private market may not produce a good even if the benefits to those that would
receive it are worth more than the cost of production. Let’s take for example a public
road that needs to be built to replace a dirt path leading to a new community. The project
may have a total cost of $50,000, but the 100 residents are each willing to pay $1000 for
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the good. The total benefit of the road to all 100 residents is valued at $100,000—
sufficiently more than the cost it would incur. Why, then, would a private firm not want
to construct the road? Each resident understands that he would be able to still enjoy the
road, as long as it was built, regardless of how much he contributed to its production
costs. Each resident, therefore, tries to understate what the value of the road is, in order
to drive the cost to a lower, or zero, cost. An individual who has an incentive to behave
this way, then, is called a free-rider. If enough people behave in this manner, then the
road will not be constructed.

When a good is public, it is understandable why someone would want to be a free-rider.

Why pay when you don’t need to? However, it is this rationale that makes it difficult for
a private market to provide this good for the residents. In fact, the severity of this
problem increases as the number of individuals that stand to benefit increases. As the
group sizes increases, it is more likely than before that an individual would free-ride, thus
decreasing the possibility of the good’s providence.

Instead of a small community, let us designate the road as one leading to a new town.
This town has 5000 residents, each who stand to benefit by a value of $20. The total
benefit remains $100,000. Each person believes that their contribution will not matter, as
there are 4999 other residents who may contribute voluntarily and the road will still be
built. In this case, this individual can still benefit from the produced good without having
to pay a dime. As before, however, each person is inclined to think in this manner, and
more so than before because there is a greater drowning-out effect. Fewer people would
contribute and the good would not be produced.

One real-world example of this concept involves a device that General Motors tried to
market in the early 1970’s. Before regulatory pollution controls, this device was set to
reduce pollution emitted by 30 to 50 percent; it costed $20 per car. It can be seen that the
benefit of this far outweighed the mere cost—but nobody bought this product. Why? For
the same reason why the road was not built. The large-group free-rider problem
prevailed; everyone would have been better off had everyone bought the device, but it
was not in any one individual’s interest to do so. And because it was not in any one
person’s interested to do so, it was not done.

So how do you incite production of something that is of benefit to everybody, but is not
produced because people are scoundrels that look after only themselves and don’t see the
larger picture? Communism! Communism! Communism!

No, just kidding, but you do need government intervention. If in the town everyone was
taxed $10 (instead of asked for a voluntary contribution), the cost of the road $50,000
would be raised. Thus, each person would receive a $20 benefit for only 10 tax dollars.
The government expedition of $50,000 on the road would be more efficient resource
allocation than if the private sector had been relied upon to provided the good.

Efficiency
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We have decided to produce, and how to do so—we now ask ourselves the next
fundamental question. How much do we produce? Predictably, we engage in cost-
benefit analysis and play along the margins. We need to figure out where marginal cost
and marginal benefit plot and meet. What is different in this scenario, however, is that
we are dealing with a public good. Such an addition of a nonrival good benefits no single
individual, so we just consider the total of marginal benefits of the whole population in
question.

An Example

Figure 18.a.1 below illustrates the demand and supply curves of a public good, waste
management services. We use garbage trucks as a representative. We derive the social
marginal benefit curve, MCS (the demand curve for the whole population) from the
demands of the only two people in the community, Jerry and Huey. Recall that the height
of a demand curve is the marginal benefit of an additional unit of a good—this is why
this vertical summation of the demands works.

To illustrate this point, if you add the marginal benefit to Jerry from the first truck, $700,
to the marginal benefit to Huei from the first truck, $500, you receive the social marginal
benefit, $1200, of the first unit of waste management. Continue this and you see that the
MBS curve truly is traced out of the vertical summation of the DJ and DH curves.
Dollars per
Truck Figure 18.a.1
The most efficient
1200
point of production
is where the
1000 MC vertical summation
of the population’s
demand for the
good, the Social
700 Marginal Benefit
600 DJ Curve Marginal
MB S Cost (MBS) meets
500
the Marginal Cost
400 (MC). In this
case, $1000 paid
for each of 50
DH trucks is where
production should
occur.
50
Trucks

With this established, we move on to determine where the point of maximum efficiency
lies. Realize that the marginal cost curve, MC, is arbitrarily drawn as a horizontal line for
the sake for simplicity. At every point prior to 50 trucks, Jerry and Huey together are
willing to pay more than the trucks cost—so more units are produced in order to achieve
a more efficient output. When MBS lies below the MC curve, more units are being
produced than desired. That is, the cost exceeds the combined benefit to Jerry and Huei
of every truck beyond the 50th. Thus, the most efficient level of output is where the two
marginal curves meet, at 50 units.
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Recall that the free-rider problem makes it improbable that the private sector would
tackle such a task of providing a nonrival good; this lends way for the public sector to
address the issue. However, it is not so easy. As it is for most other economic issues, it
is virtually impossible to determine how to quantify such subjective items. How do you
measure one’s demand for a good such as a public swimming pool, highways, or even
national defense? You cannot do it accurately, so you cannot possibly precisely quantify
the demands of an entire community for such a good.

Other problems arise. Let us say that you were able to tax an individual according to how
much that person values a benefit at any given output. But, then that individual would
understate that benefit as a reaction to the tax in order to partially free-ride. People will
always try to find a way to cheat.

Patents

Initially, it would seem inefficient to exclude (if one could) anyone else from the benefits
of a nonrival good. In general, knowledge is nonrival in consumption. One’s use of it
does not take away from another’s ability to. However, acquiring knowledge, or
research, does require the input of resources. A party devoting time and money into the
research of a new vaccine or drug would have no incentive to do so if they were not able
to keep that knowledge a private asset. If they were not able to protect it—or not able to
patent—then the free-rider problem arises again and life-saving drugs may never be
discovered. The public policy of patents preserves the inducement for advances to be
made that could be bolstered by a profit incentive. This protection also tends to an
inefficiently distributed; however, the benefits must be weighed against the costs, again.

Questions
1. Define what it means for a good to be nonrival in consumption.
2. Give an example of a good that is nonrival in consumption.
3. Define what it means for a good to be nonexclusive.
4. Give an example of a good that is nonexclusive.
5. What can a good be considered if it fulfills both criteria mentioned above?
6. Define what it means to be a free-rider.
7. Give an example of how you have been a free-rider
8. Give a solution for which a public good may be provided in spite of the free-rider
effect.
9. Name the process by which the social marginal benefit curve is derived.
10. At what point is production most efficient for a public good?
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Answers
1. A good can be considered nonrival in consumption if one’s consumption of that
good does not affect the quantity consumed by other individuals.
2. Does the answer fit the definition above?
3. A condition that is characterizes nonexclusion can be thought of one in which a
good’s benefits cannot be confined (or be prohibitively costly to do so) once
produced.
4. Does the answer fit the definition above?
5. A public good.
6. A individual who understates his/her benefit from a good in order to drive his/her
own cost lower or to zero.
7. It’s your fault that we have air pollution! All your fault!
8. Government implementation/ tax remedies.
9. Vertical summation, of individual demand curves.
10. When the good is produced at a point in which Marginal Cost meets the Marginal
Benefit to society.