© 2007 Thomson South-Western

Public Goods and Common Resources

• “The best things in life are free. . .”
– Free goods provide a special challenge for economic
analysis.
– Here we show that Government/Organizational
intervention is necessary to ensure that public goods such
as forests are not over-used by private bodies.
– Most goods in our economy are allocated in markets…

© 2007 Thomson South-Western

Public Goods and Common Resources
• When goods are available free of charge, the
market forces that normally allocate resources
in our economy are absent.
• When a good does not have a price attached
to it, private markets cannot ensure that the
good is produced and consumed in the proper
amounts.

© 2007 Thomson South-Western

Public Goods and Common Resources
• In such cases, government policy can
potentially remedy the market failure that
results, and raise economic well-being.

© 2007 Thomson South-Western

THE DIFFERENT KINDS OF
GOODS
• When thinking about the various goods in the
economy, it is useful to group them according
to two characteristics:
– Is the good excludable?
– Is the good rival?

© 2007 Thomson South-Western

THE DIFFERENT KINDS OF
GOODS
• Excludability
– refers to the property of a good whereby a person
can be prevented from using it.
• Rivalry in consumption
– refers to the property of a good whereby one
person’s use diminishes other people’s use.

© 2007 Thomson South-Western

THE DIFFERENT KINDS OF
GOODS
• Four Types of Goods
– Private Goods
• Goods that are both excludable and rival in consumption
– Public Goods
• Goods that are neither excludable nor rival in consumption
– Common Resources
• Goods that are rival in consumption but not excludable
– Natural Monopolies
• Goods that are excludable but not rival in consumption

© 2007 Thomson South-Western

 Figure 1 Four Types of Goods

Rival?
Yes No
Private Goods Natural Monopolies

Yes • Ice-cream cones • Fire protection

• Clothing • Cable TV
• Congested toll roads • Uncongested toll roads
Excludable?
Common Resources Public Goods

No • Fish in the ocean • Tornado siren

• The environment • National defense
• Congested nontoll roads • Uncongested nontoll roads

© 2007 Thomson South-Western

PUBLIC GOODS
• A free-rider is a person who receives the
benefit of a good but avoids paying for it.

© 2007 Thomson South-Western

The Free-Rider Problem

• Since people cannot be excluded from enjoying

the benefits of a public good, individuals may
withhold paying for the good hoping that others
will pay for it.
• The free-rider problem prevents private markets
from supplying public goods.
• Who will free ride? Sequentiality important:
First/Last Mover’s advantage

© 2007 Thomson South-Western

The Free-Rider Problem

• Solving the Free-Rider Problem

• Suppose a road needs to be built in a village. A
canal needs to be constructed to address the water
scarcity in a village. Who will pay for it?
• The government can decide to provide the public
good if the total benefits exceed the costs.
• The government can make everyone better off by
providing the public good and paying for it with tax
revenue.

© 2007 Thomson South-Western

Comtribution Game

• Suppose three neighbours X, Y and Z are

approached SEQUENTIALLY one after
another (starting from X, then Y, then Z) to ask
if they would like to Contribute (denoted by C)
or Not Contribute (denoted by NC) towards the
building of a public park in the neighbourhood.
• The park will be built if at least two members
Contribute (play C).

© 2007 Thomson South-Western

• The act of having the park is denoted by P. and
the act of not having the park is denoted by NP.
• The utility of every agent is the same, and is
goven as follows:
• Gets 4 if NC and P
• Gets 3 if C and P
• Gets 2 if NC and NP
• Gets 1 if C and NP

© 2007 Thomson South-Western

• Given this, the game tree is drawn which is a
flowchart of all the possible outcomes.
• The process of Backward Induction is applied,
which starts from the last round where Z is
approached. How would he react to the
different scenarios , that is, the different
histories of how X and Y have reacted in the
earlier two rounds?

© 2007 Thomson South-Western

• Given How Z will behave in the third round,
one moves to the second round, and determines
how Y will behave given that he knows how Z
will behave in the third round.
• Given How Y and Z will behave in the second
and third rounds, one moves to the first round,
and determines how X will behave given that
he knows how Y and Z will behave in the
second and third rounds.

© 2007 Thomson South-Western

• By this approach, it is clear that X will not
contribute, while Y and Z will contribute.
• Hence there is a First Mover’s Advantage in
this setting.
• However, there are other settings where in there
may be a Last Mover’s Advantage.

© 2007 Thomson South-Western

Some Important Public Goods

• National Defense
• Basic Research
• Fighting Poverty

© 2007 Thomson South-Western

CASE STUDY: Are Lighthouses Public
Goods?
• Benefit is neither excludable nor rival in consumption
for ship captains
• Because of free-rider problem, private
• markets generally don’t provide lighthouses
• 19th century England, lighthouse owners
charged local port
• If port didn’t pay, light turned off
• Ships avoided that port

© 2007 Thomson South-Western

The Difficult Job of Cost-Benefit Analysis

• Cost-benefit analysis refers to a study that

compares the costs and benefits to society of
providing a public good.
• In order to decide whether to provide a public
good or not, the total benefits of all those who
use the good must be compared to the costs of
providing and maintaining the public good.

© 2007 Thomson South-Western

The Difficult Job of Cost-Benefit Analysis

• A cost-benefit analysis would be used to

estimate the total costs and benefits of the
project to society as a whole.
• It is difficult to do because of the absence of prices
needed to estimate social benefits and resource
costs.
• Without accurate prices, it is difficult to assess
attributes like…
• the value of life
• the value of consumers’ time, and
• the aesthetics of public good projects.

© 2007 Thomson South-Western

COMMON RESOURCES

• Common resources, like public goods, are not

excludable. They are available free of charge
to anyone who wishes to use them.
• Common resources are rival goods because
one person’s use of the common resource
reduces other people’s use.

© 2007 Thomson South-Western

Tragedy of the Commons

• The Tragedy of the Commons is a parable that

illustrates why common resources get used
more than is desirable from the standpoint of
society as a whole.
• Common resources tend to be used excessively
when individuals are not charged for their usage.
• This is similar to a negative externality.

© 2007 Thomson South-Western

Some Important Common Resources

• Clean water
• Congested roads
• Fish, whales, and other wildlife

© 2007 Thomson South-Western

IN THE NEWS: A Solution to City
Congestion
• Motorists driving into central London on
weekdays between 7:00 A.M. and 6:30 P.M. pay a
daily tax of about $9.50.
• Cameras record license plate numbers and
nonpayers are charged stiff penalties.
• Congestion in central London has decreased by
30%.
• 50,000 fewer cars enter the eight square mile
“restricted area” each day.
© 2007 Thomson South-Western
CASE STUDY: Why the Cow Is Not Extinct

• What will protect me?

Private
Ownership and
the Profit
Motive!

© 2007 Thomson South-Western

IN THE NEWS: Should Yellowstone
Charge as Much as Disney World?
• National parks can be viewed as either public
goods or common resources.
• If park congestion is light, visits are not rival in
consumption.
• As congestion increases, park entrance fees
could be raised.
• The likely increase in revenues…
• could be used to improve national parks, and
• would encourage others to develop new parks.
© 2007 Thomson South-Western
CONCLUSION: THE IMPORTANCE OF
PROPERTY RIGHTS
• The market fails to allocate resources efficiently
when property rights are not well-established
(i.e. some item of value does not have an owner
with the legal authority to control it).
• When the absence of property rights causes a
market failure, the government can potentially
solve the problem.

© 2007 Thomson South-Western

 Summary

• Goods differ in whether they are excludable

and whether they are rival.
– A good is excludable if it is possible to prevent
someone from using it.
– A good is rival if one person’s enjoyment of the
good prevents other people from enjoying the
same unit of the good.

© 2007 Thomson South-Western

 Summary

• Public goods are neither rival nor excludable.

• Because people are not charged for their use of
public goods, they have an incentive to free
ride when the good is provided privately.
• Governments provide public goods, making
quantity decisions based upon cost-benefit
analysis.

© 2007 Thomson South-Western

 Summary

• Common resources are rival but not

excludable.
• Because people are not charged for their use of
common resources, they tend to use them
excessively.
• Governments tend to try to limit the use of
common resources.

© 2007 Thomson South-Western