Public goods and openaccess common property II part

1
Public goods and open-access common property(II
part)
2
3) Club goods no rivalry but exclusion

• No rivalry gt MC of use 0 once the product has
  been produced.
• Imagine a bridge. The cost per car crossing the
  bridge is very close to zero given that it has
  been built and that there is no congestion.
• Can be illustrated as follows

3
Assume that the operator demands a fee for
crossing the bridge. (e.g. the project is
supposed to be self-financed gt expected ATC
P). Fee P P1 and MC0 (or never above
P1anyway) Q1car-owners have MWTP P1. What happen
to the social benefits from the bridge when the
fee is introduced?
P
D
MC0
P1
Q
Q1
4
Assume that the operator demands a fee for
crossing the bridge. (e.g. the project is
supposed to be self-financed gt expected ATC
P). Fee P P1 and MC0 (or never above
P1anyway) Q1car-owners have MWTP P1. What
happen to the social benefits from the bridge
when the fee is introduced?
P
QS-Q1 have MWTPgt0 but are excluded. Excluding
them from crossing, is not efficient since MWTP gt
MC0
D
MC0
Efficiency loss
P1
Other examples are cinemas, concerts, lectures
and swimming-clubs. Given no congestion.
Q
Q1
QS
5
Demand for Private goods

• Assume two individuals Sara and John.
• They consume one type of good
• Saras respectively Johns demand for the good is
  given by the following demand curves

Horizontal aggregation Given P, how many Q?
How do we derive the total demand curve?
P
P
P
Sara
John
dS
7
7
dJ
3
3
q
q
q
7
3
4
4
4711
6
Demand for Private goods

• Assume two individuals Sara and John.
• They consume one type of good
• Saras respectively Johns demand for the good is
  given by the following demand curves

Horizontal aggregation Given P, how many Q?
How do we derive the total demand curve?
P
P
P
P7gt Q0 P3gt Q 3 P0gt Q11
Sara
John
7
7
Reflects MWTP
3
3
3
q
q
q
7
3
3
4
4711
7
Important Remark
The aggregation just done is only valid for
private goods, PUBLIC GOODS REQUIRES VERTICAL
AGGREGATION!!!!! Assume that Sara and John
consumes a genuine public good. Every good can
be consumed by Sara and John at the same time gt
single goods are valued by both consumers.
The demand curves are drawn in the same way as
for the private good to illustrate the contrast
to horizontal aggregation.
8
4) Genuine public goods (Demand curve)
The demand curves are drawn in the same way as
for the private good to illustrate the contrast
to horizontal aggregation.
Vertical aggregation Whats the WTP for the ith
good?
P
P
P
10
Sara
John
7
3
3
2
q
q
Q
7
4
7
4
9
4) Genuine public goods (Demand curve) (cont.)
The demand curves are drawn in the same way as
for the private good to illustrate the contrast
to horizontal aggregation.
Vertical aggregation Whats the WTP for the ith
good?
1th good WTP WTPS WTPJ 3 7 10 4d
good WTP 2 0 2 7th good WTP 0 0 0
P
P
P
10
Sara
John
7
3
3
2
2
q
q
Q
7
4
7
4
4
10
4) Genuine public goods (Demand curve) (cont.)
The demand curves are drawn in the same way as
for the private good to illustrate the contrast
to horizontal aggregation.
Vertical aggregation Whats the WTP for the ith
good?
1th good WTP WTPS WTPJ 3 7 10 3d
good WTP 2 0 2 7th good WTP 0 0 0
P
P
P
10
DPublic
Sara
John
7
3
3
2
2
q
q
Q
7
4
4
4
7
11
Optimal Provision of Public Goods

• For a public good, everyone is provided the same
  quantity of public goods.
• The marginal benefit (willingness to pay) of
  public goods can vary by person.
• To, derive aggregate demand curve, we hold
  Quantity constant, add together individual
  benefit (willingness-to-pay) to get total
  benefit.
• Vertical Summation

12
Optimal Provision of Private Goods

• For a private good, consumers demand different
  quantities at the same market price (a key
  feature of the private market equilibrium).
• To derive the aggregate demand curve, we fix the
  price, and add up the quantities individuals
  demand at that price.
• Horizontal Summation

13
Why in horizontal or vertical?

• We sum private goods horizontally, because
  consumers cannot comsume the same units.
• Aggregate demand in the economy for a public good
  is the vertical sum of individual demand curves.
  Demand is summed vertically, because all
  individuals can enjoy the same.

14

• Optimal production of public good

The big difference between a private- and a
public good is in the way we aggregate demand.
Optimal supply of the public good is given
by MWTP MC, meaning that the societys
willingness to pay for the last produced unit is
equal to its production cost.
MC
DPublic
10
2
Q
4
3
7
QS
15
Valuing public goods

• Markets seldom exists for genuine public
  goods.
• Why? They are not excludable why pay for
  something you will get anyway?
• Solution The government till provides the good
  instead.
• Difficult to assess value to the society
• No market gt no price gt difficult to reveal the
  demand-curve gt difficult to value
• gtdifficult to determine the optimal supplygt
  Back to the direct and indirect methods

16
Methods to value of a public good

• 1) Direct method Ask people how much they are
  willing to pay for
• preserving x hectare forest. Sum over the
  population to get the total value.
• Problems Hypothetical questions do people have
  complete information?
• Individuals may have incentives to lie
• If individuals really like the good (or service)
  gt state too high WTP.
• If they do not like the good gt State a too low
  (probably WTP0)

Free riding Many people are unwilling to pay for
their share of the public good, even though they
like to have it. They rather see that other
people pay for the good, so they can free-ride
benefit from the actions of others without
paying. (positive externality attached to
others consumption)
17
Methods to value of a public good

• 2) Indirect method Use empirical relationship
  between the public good and a priced good.
• EX1. If an individual spends SEK 1000 on travel
  costs to visit a park, the park should be worth
  at least that amount (SEK 1000). Sum travel cost
  for all visitors to get a lower bound of the
  total value.
• EX2. Compare prices of a standard house in an
  area close to a specific park and a house in an
  area further away from the park. Difference in
  prices times the number of houses in the area
  close to the park is equal to a lower bound of
  the parks total value to society.
• Problem Empirical relationships to human
  behavior does not exist for all public goods,
  e.g. existence value attached to specific species
  (elephant).

18
Methods to value of a public good

• 3) Look at similar projects that already have
  been introduced.
• Problem Zero price gt impossible to reveal
  demand-curve. (visits do not say anything about
  the value)
• Are the projects that similar? If not, values do
  not apply.

19
Does the competitive market work well?

• The competitive market equilibrium is socially
  efficient for a private good
• Unfortunately, the competitive market provides
  public goods less than the optimal level.
• Intuition Free rider problem

20
Why public goods cause market failures

• The primary cause of market failure involving
  public goods is non-excludability.
  Non-excludability means that the producer of a
  public good cannot prevent individuals from
  consuming it.
• Non-excludability is a relative, not an absolute,
  characteristic of most public goods. A good is
  usually termed non-excludable if the costs of
  excluding individuals from consuming the good are
  very high. Private Markets often under-provide
  non-excludable public goods because individuals
  have the incentive to free ride, or to not pay
  for the benefits they receive from consuming the
  public good.
• With a free-rider problem, private firms cannot
  earn sufficient revenues from selling the public
  good to induce them to produce the socially
  optimal level of the public good.

21
Private Provision the Free Rider Problem

• This incentive to let others pay for the public
  good while still enjoying the benefits is known
  as the free rider problem.
• This incentive to free ride occurs because the
  public good is nonexcludable.
• The private market therefore fall short of
  providing the efficient amount of the public
  good.
• What if the good is excludable? What price to
  charge for non-rival good?

22

• EX. The problem of free-riding
• Assume that a statue is to be raised in a
  village park.
• Cost for statue SEK 1000
• The village has 20 members, each of them has
  WTP SEK 200.
• Total value is equal to SEK 4000 gt ?

23

• EX. The problem of free-riding

• Total value is equal to SEK 4000 gt The statue
  should be raised.
• Waylon is suppose to collect money and buy the
  statue. To be on the safe side he collects SEK 60
  (20 x 601200) from each person.
• Given that all individuals pay, some can escape,
  but still utilize the statue. Problem too many
  members think they can escape the payment
  (free-ride).
• The statue is never raised. (provision less than
  the optimal level)

24
EX. The problem of the free-riding

• Solutions
• 1. The village policy maker collects a tax and
  buys the statue.
• 2. Waylon let the members know that he will
  publish a list on the web revealing who has paid
  (social pressure). May work!
• The government solves the problem of a missing
  market, i.e. corrects a market failure and
  improves the social welfare!

25
Providing the Socially-Optimal level of Public
Goods

• D1 Demand of one individual for public good X.
• D2 Total Demand of two individuals for public
  good X.
• D3 Total Demand of three individuals for public
  good X.
• D4 Total Demand of four individuals for public
  good X.
• MC Marginal cost of providing the public good X.

Because of non-excludability, markets may fail to
provide X4.For example, if individual 1 decides
to purchase (and the others free-ride), the
private market will provide a level of the public
good equal to X1, where the marginal benefit of
the purchasing individual equals the marginal
cost of providing the public good. Notice that
this is much less than the optimal level of
provision of the public good, X4.
26
Providing the Socially-Optimal level of Public
Goods

• When the private market fails to provide the
  efficient level of public goods, provision of
  public goods requires collective action.
• People need to realize that a public goods
  situation exists and either raise contributions
  from private individuals to fund the public good
  or let the government provide the public good.

27
Providing the Socially-Optimal level of Public
Goods

• Mechanisms to provide public goods include
• Civic responsibility, individual volunteerism,
  private fund raising and donation (Examples
  donations to the Arts for symphony halls,
  volunteer fire departments, nature reserves
  financed by groups such as the Nature
  Conservatory)
• (2) Private provision of excludable public goods
  (Examples movies, music concerts)
• (3) Public provision of excludable public goods
  through the use of entrance fees (Example
  entrance fees for a National Park)
• (4) Public provision of non-excludable public
  goods through the use of general government tax
  revenues (Example taxes earmarked for National
  Defense)
• (5) Religious beliefs (Examples church services
  are a public good during the ceremony a basket
  is passed around for collections. Religion can
  prevent free-riding by convincing people that
  God is watching.