ANNOUNCEMENTS

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ANNOUNCEMENTS
Exam 2 Thursday, November 11 Chapters
7-11, 13. Homework 3, due Tuesday, November
9, can be downloaded from the course Web
site. NO LATE PAPERS WILL BE ACCEPTED.
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DEFINITION
A good is rival if one persons use of it
reduces another persons enjoyment of the
good. A steak dinner is rival because, when one
person consumes the steak, it cannot be eaten by
anyone else. A radio broadcast is not rival,
because many people can listen to the broadcast
without reducing the ability of others to listen.
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DEFINITION
A good is excludable if people can be prevented
from using it once it has been produced. Cable
TV is an excludable good, because a cable hookup
is required to receive the programming. Broadcast
radio and TV are not excludable, because once
the program is broadcast, anyone with a ratio or
television receiver can tune into the program.
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A TAXONOMY OF GOODS

Rival
Not Rival

Private Goods Natural
Monopolies
Ice-cream cones
Fire protection Excludable Clothing
Cable
TV Congested toll
roads Uncongested toll
roads Common
Resources Public Goods Not
Fish in the ocean
National defense Excludable The
environment
Knowledge Congested
nontoll roads Uncongested
nontoll roads
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PRIVATE GOODS
Private goods are both rival and excludable. We
have seen that competitive markets efficiently
allocate resources for private goods when there
are no externalities in production or
consumption. Furthermore, when there are no
externalities, government interference with
competitive markets for private goods causes a
misallocation of resources.
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EXTERNALITIES
When there are externalities competitive
markets do not allocate resources efficiently and
government interference can improve the
allocation of resources.
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PUBLIC GOODS
Competitive markets also fail to allocate
resources efficiently for public goods. The
reason is that public goods are not
excludable. Once one or more persons pay for the
provision of the public good, it is freely
available for use by anyone else -- whether they
pay or not. This causes a free rider problem --
people enjoying the benefits of a public good
without helping to pay for the cost of supplying
the good.
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PUBLIC GOODS
There are only two individuals in a community
with TVs. Their demand schedules are given at
the left, along with the TV stations supply
schedule.
Hourly
Hourly Hours of value to value
to Supply public TV Smith
Jones 1 100
60 60 2
95 55 65 3
90 50
70 4 85
45 75 5
80 40 80
6 75
35 85 7
70 30 90
8 65 25
95 9 60
20 100 10
55 15
105
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PUBLIC GOODS
Smith pays for public TV broadcasts, while Jones
is a free rider. Smith will benefit from a hour
of TV as long as the value of the hour to him is
greater than what
Hourly
Hourly Hours of value to value
to Supply public TV Smith
Jones 1 100
60 60 2
95 55 65 3
90 50
70 4 85
45 75 5
80 40 80
6 75
35 85 7
70 30 90
8 65 25
95 9 60
20 100 10
55 15
105
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PUBLIC GOODS
he must pay the TV station for providing it.
Smiths quantity demanded and the TV stations
quantity supplied are equal to 5 at a price of
80 per
Hourly
Hourly Hours of value to value
to Supply public TV Smith
Jones 1 100
60 60 2
95 55 65 3
90 50
70 4 85
45 75 5
80 40 80
6 75
35 85 7
70 30 90
8 65 25
95 9 60
20 100 10
55 15
105
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PUBLIC GOODS
hour (a total cost of 80 x 5 400 to Smith).
When 5 hours are broadcast, Jones also receives
value from the broadcast without paying.
Hourly Hourly
Supply Hours of value to
value to (social public TV Smith
Jones cost) 1
100 65 60 2
95 60
65 3 90
55 70 4
85 50 75
5 80
45 80 6
75 40 85
7 70 35
90 8 65
30 95 9
60 25
100 10 55
20 105
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PUBLIC GOODS
The total social benefit is Smiths consumer
surplus, the TV stations producer surplus, and
Jones consumer surplus.
Note that since Jones pays a zero price, the
surplus is the entire area under the demand curve.
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PUBLIC GOODS
Consumer surplus for Smith is (105-80) x
5/262.5. Consumer surplus for Jones is 45 x 5
(70-45) x 5/2 312.5. Producer
Surplus is (80-55) x 5/2 62.5. Therefore the
total surplus is 437.5.
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PUBLIC GOODS
Since the value of the fifth hour to Smith is
80, and the value of the fifth hour to Jones is
45, total social value of the fifth
hour is 120. However social cost is only 80, so
that the sum of consumer and producer surplus can
be
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PUBLIC GOODS
increased by using more resources to produce
more hours of TV.
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PUBLIC GOODS
Adding together Smiths and Jones values
for hours of public TV, total social value
exceeds total social cost up to 8 hours of TV.
Hourly Hourly
Total Supply Hours of value to
value to social (social public TV
Smith Jones value cost)
1 100 65 165
60 2 95
60 155 65 3
90 55 145
70 4 85
50 135 75 5
80 45 125 80
6 75 40
115 85 7
70 35 105 90
8 65 30
95 95 9
60 25 85 100
10 55 20
75 105
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PUBLIC GOODS
Since public TV is not rival, both Smith and
Jones receive their full value from each of the
hours of TV. Therefore, Jones demand is added
on top of Smiths. Then the welfare maximizing
output
is 8 hours. Consumer surplus is (175-95) x
8/2320, and producer surplus is (95-55) x
8/2160. Then
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PUBLIC GOODS
the total surplus for 8 hours is 480 compared
to 437.5 for 5 hours. Because Jones is a free
rider there are too few resources allocated
to public TV and social welfare is not maximized.
If Smith
pays her valuation of 8 hours (65) and Jones
pays his valuation of 8 hours (30), each will
benefit, and
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PUBLIC GOODS
resources will be efficiently allocated. One way
to determine the optimal level of output of a
public good is to survey all potential consumers
to determine what value they place on the
provision of the good. Summing these values
gives the value to society which can then be
compared to social cost. Besides the enormous
problem of contacting everyone to determine
their valuation of the public good, there is a
strong likelihood that respondents
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PUBLIC GOODS
will not be truthful about their valuation since
they know they may be charged what they report.
Since they can be a free rider, everyone has
every incentive to underreport his valuation.
In this situation there would be an
underprovision of the public good. Therefore
provision of public goods is better left to
government to provide out of tax revenues, since
the market fails to efficiently allocate
resources to the provision of public goods.
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COMMON RESOURCES
Goods that are rival, but not excludable
are classified as common resources. Examples
are fish in ocean fisheries, the environment
(air, water, public forests), congested freeways,
and public picnic grounds on summer holidays.
Since these are not excludable, every citizen
has an incentive to exploit these resources to
the point where they obtain no additional value.
This causes overuse. Ocean fisheries may be
fished to extinction because,
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COMMON RESOURCES
a fisherman believes that if he doesnt get the
fish, someone else will, and there will be fewer
left for him as a result. Robert Coase has
shown that the problem is that no one has, or
can exercise, any property rights on these
resources. If property rights to the common
resources were assigned, then the owner could
exclude users, making these resources rival and
excludable, i.e., making them private goods. If
there are no externalities
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COMMON RESOURCES
associated with the resources, competitive
markets would allocate the use of these resources
efficiently. This is the idea of the Coase
Theorem. Assigned pollution rights is a form of
property rights, and a competitive market for
these rights can lead to an efficient use of the
environment when the proper amount of rights is
assigned.