Public Goods and Common Resources

1
16
CHAPTER
Public Goods and Common Resources
2
After studying this chapter you will be able to

• Distinguish among private goods, public goods,
  and common resources
• Explain how the free-rider problem arises and how
  the quantity of public goods is determined
• Explain the tragedy of the commons and its
  possible solutions

3
Free Riding and Overusing the Commons

• Why does government provide some goods and
  services such as the enforcement of law and order
  and national defense?
• Why dont we let private firms produce these
  items and leave people to buy the quantities they
  demand?
• Ocean fish are a common resource that everyone is
  free to take.
• Are our fish stocks being depleted? What can be
  done to conserve the worlds fish?

4
Classifying Goods and Resources

• What is the essential difference between
• A city police department and Brinks security
• Fish in the Atlantic Ocean and fish in a fish
  farm
• A live concert and a concert on television
• These and all goods and services can be
  classified according to whether they are
  excludable or nonexcludable and rival or nonrival.

5
Classifying Goods and Resources

• Excludable
• A good is excludable if only the people who pay
  for it are able to enjoy its benefits.
• Brinkss security services, East Point Seafoods
  fish, and a Coldplay concert are examples.
• Nonexcludable
• A good is nonexcludable if everyone benefits from
  it regardless of whether they pay for it.
• The services of the LAPD, fish in the Pacific
  Ocean, and a concert on network television are
  examples.

6
Classifying Goods and Resources

• Rival
• A good is rival if one persons use of it
  decreases the quantity available for someone
  else.
• A Brinkss truck cant deliver cash to two banks
  at the same time. A fish can be consumed only
  once.
• Nonrival
• A good is nonrival if one persons use of it does
  not decrease the quantity available for someone
  else.
• The services of the LAPD and a concert on network
  television are nonrival.

7
Classifying Goods and Resources

• A Four-Fold Classification
• Private Goods
• A private good is both rival and excludable.
• A can of Coke and a fish on East Point Seafoods
  farm are examples of private goods.
• Public goods
• A public good is both nonrival and nonexcludable.
  A public good can be consumed simultaneously by
  everyone, and no one can be excluded from
  enjoying its benefits.
• National defense is the best example of a public
  good.

8
Classifying Goods and Resources

• Common Resources
• A common resource is rival and nonexcludable.
• A unit of a common resource can be used only
  once, but no one can be prevented from using what
  is available. Ocean fish are a common resource.
• They are rival because a fish taken by one person
  isnt available for anyone else.
• They are nonexcludable because it is difficult to
  prevent people from catching them.

9
Classifying Goods and Resources

• Natural Monopolies
• In a natural monopoly, economies of scale exist
  over the entire range of output for which there
  is a demand.
• A special case of natural monopoly arises when
  the good or service can be produced at zero
  marginal cost. Such a good is nonrival. If it is
  also excludable, it is produced by a natural
  monopoly.
• The Internet and cable television are examples.

10
Classifying Goods and Resources

• Figure 16.1 shows this four-fold classification
  of goods and services.

11
(No Transcript)
12
Classifying Goods and Resources

• Two Problems
• Public goods create a free-rider problemthe
  absence of an incentive for people to pay for
  what they consume.
• Common resources create a problem called the
  tragedy of the commonsthe absence of incentives
  to prevent the overuse and depletion of a
  resource.

13
Public Goods and the Free-Rider Problem

• The value of a private good is the maximum amount
  that a person is willing to pay for one more unit
  of it.
• The value of a public good is the maximum amount
  that all the people are willing to pay for one
  more unit of it.
• To calculate the value placed on a public good,
  we use the concepts of total benefit and marginal
  benefit.

14
Public Goods and the Free-Rider Problem

• The Benefit of a Public Good
• Total benefit is the dollar value that a person
  places on a given quantity of a good.
• The greater the quantity of a good, the larger is
  a persons total benefit.
• Marginal benefit is the increase in total benefit
  that results from a one-unit increase in the
  quantity of a good.
• The marginal benefit of a public good diminishes
  with the level of the good provided.

15
Public Goods and the Free-Rider Problem

• Figure 16.2 shows how the marginal social benefit
  of a public good is the sum of marginal benefits
  of everyone at each quantity of the good
  provided.
• Part (a) shows Lisas marginal benefit.
• Part (b) shows Maxs marginal benefit.

16
(No Transcript)
17
Public Goods and the Free-Rider Problem

• The economys marginal social benefit of a public
  good is the sum of the marginal benefits of all
  individuals at each quantity of the good
  provided.
• The economys marginal social benefit curve for a
  public good is the vertical sum of all individual
  marginal benefit curves.

18
(No Transcript)
19
Public Goods and the Free-Rider Problem

• The marginal social benefit curve for a public
  good contrasts with the demand curve for a
  private good, which is the horizontal sum of the
  individual demand curves at each price.

20
Public Goods and the Free-Rider Problem

• The Efficient Quantity of a Public Good
• The efficient quantity of a public good is the
  quantity that maximizes net benefittotal benefit
  minus total cost.
• This quantity is the same as the quantity at
  which marginal social benefit equals marginal
  social cost.

21
Public Goods and the Free-Rider Problem

• The total cost curve, TC, is like the total cost
  curve for a private good.
• The total benefit curve, TB, is just the sum of
  the marginal benefit at each output level.
• The efficient quantity is where net benefit is
  maximized.

22
(No Transcript)
23
Public Goods and the Free-Rider Problem

• Equivalently, the efficient quantity is produced
  where marginal social benefit equals marginal
  social cost.
• If marginal social benefit exceeds marginal
  social cost, net benefit will increase if output
  is increased.

24
(No Transcript)
25
Public Goods and the Free-Rider Problem

• If marginal social cost exceeds marginal social
  benefit, net benefit will increase if output is
  decreased.
• So the quantity at which marginal social benefit
  equals marginal social cost maximizes net benefit.

26
Public Goods and the Free-Rider Problem

• Private Provision
• If a private firm tried to produce and sell a
  public good, almost no one would buy it.
• The free-rider problem results in too little of
  the good being produced.

27
Public Goods and the Free-Rider Problem

• Public Provision
• Because the government can tax all the consumers
  of the public good and force everyone to pay for
  its provision, public provision overcomes the
  free-rider problem.
• If two political parties compete, each is driven
  to propose the efficient quantity of a public
  good.
• A party that proposes either too much or too
  little can be beaten by one that proposes the
  efficient amount because more people vote for an
  increase in net benefit.

28
Public Goods and the Free-Rider Problem

• Principle of Minimum Differentiation
• The attempt by politicians to appeal to a
  majority of voters leads them to the same
  policiesan example of the principle of minimum
  differentiation.
• The principle of minimum differentiation is the
  tendency for competitors to make themselves
  similar so as to appeal to the maximum number of
  clients (voters).
• (The same principle applies to competing firms
  such as McDonalds and Burger King).

29
Public Goods and the Free-Rider Problem

• The Role of Bureaucrats
• Figure 16.4 shows the goal of bureaucrats, which
  is to seek the highest attainable budget for
  providing a public good.

30
(No Transcript)
31
Public Goods and the Free-Rider Problem

• Bureaucrats might provide the efficient quantity.
• But they try to increase their budget to equal
  the total benefit of the public good and drive
  the net benefit to zero.
• Bureaucrats might also try to over provide a
  public good.

32
Public Goods and the Free-Rider Problem

• Well-informed voters would ensure that
  politicians prevent the bureaucrats from
  increasing their budget above the minimum total
  cost of producing the efficient quantity.
• But is it not rational for voters to be well
  informed.

33
Public Goods and the Free-Rider Problem

• Rational Ignorance
• Rational ignorance is the decision by a voter not
  to acquire information about a policy or
  provision of a public good because the cost of
  doing so exceeds the expected benefit.
• For voters who consume but dont produce a public
  good, it is rational to be ignorant about the
  costs and benefit.
• For voters who produce a public good, it is
  rational to be well informed.
• When the rationality of uninformed voters and
  special interest groups is taken into account,
  the political equilibrium results in
  overprovision of public goods.

34
Public Goods and the Free-Rider Problem

• Two Types of Political Equilibrium
• The two types of political equilibriumefficient
  provision and inefficient overprovision of public
  goods correspond to two theories of government
• Social interest theory predicts that political
  equilibrium achieves efficiency because
  well-informed voters refuse to support
  inefficient policies.
• Public choice theory predicts that government
  delivers an inefficient allocation of
  resourcesthat government failure parallels
  market failure.

35
Public Goods and the Free-Rider Problem

• Why Government Is Large and Grows
• Two possible reasons are
• Voter preferences
• Inefficient overprovision
• Government grows because the voters demand for
  some public goods is income elastic.
• Inefficient overprovision might explain the size
  of government but not its growth rate.

36
Public Goods and the Free-Rider Problem

• Voters Strike Back
• If government grows too large relative to the
  value voters place on public goods, there might
  be a voter backlash that leads politicians to
  propose smaller government.
• Privatization is one way of coping with overgrown
  government and is based on distinguishing between
  public provision and public production of public
  goods.

37
Common Resources

• The Tragedy of the Commons
• The tragedy of the commons is the absence of
  incentives to prevent the overuse and depletion
  of a commonly owned resource.
• Examples include the Atlantic Ocean cod stocks,
  South Pacific whales, and the quality of the
  earths atmosphere.
• The traditional example from which the term
  derives is the common grazing land surrounding
  middle-age villages.

38
Common Resources

• Sustainable Production
• Figure 16.5 illustrates production possibilities
  from a common resource.
• As the number of fishing boats increases, the
  quantity of fish caught increases to some
  maximum.
• Overfishing occurs when the maximum sustainable
  catch decreases.

39
(No Transcript)
40
Common Resources

• An Overfishing Equilibrium
• Figure 16.6 shows why a common resource get
  overused.
• The average catch per boat, which is the marginal
  private benefit, MB, decreases as the number of
  boats increases.
• The marginal cost per boat is MC (assumed
  constant).

41
(No Transcript)
42
Common Resources

• Equilibrium occurs where marginal private
  benefit, MB, equals marginal cost, MC.
• In equilibrium, the resource is overused because
  no one takes into account the effects of her/his
  actions on other users of the resources.

43
Common Resources

• The Efficient Use of the Commons
• The quantity of fish caught by each boat
  decreases as the number of boats increases.
• But no one has an incentive to take this fact
  into account when deciding whether to fish.
• The efficient use of a common resource requires
  marginal social cost to equal marginal social
  benefit.

44
Common Resources

• Marginal Social Benefit
• Marginal social benefit is the increase in total
  fish catch that results from an additional boat,
  not the average catch per boat.
• The table on the next slide shows the calculation
  of marginal social benefit.

45
Common Resources
Boats Total Catch MSB
A 0 0
90
B 1 90
70
C 2 160
50
D 3 210
30
E 4 240
46
Common Resources

• Efficient Use
• Figure 16.7 shows the marginal social benefit
  curve, MSB, and the marginal private benefit
  curve, MB.
• With no external costs, the marginal social cost
  MSC equals marginal cost MC.
• The resource use is efficient when MSB equals MSC.

47
(No Transcript)
48
Common Resources

• Achieving an Efficient Outcome
• It is harder to achieve an efficient use of a
  common resource than to define the conditions
  under which it occurs.
• Three methods that might be used are
• Property rights
• Quotas
• Individual transferable quotas (ITQs)

49
Common Resources

• Property Rights
• By assigning property rights, common property
  becomes private property.
• When someone owns a resource, the owner is
  confronted with the full consequences of her/his
  actions in using that resources.
• The social benefits become the private benefits.
• But assigning property rights is not always
  feasible.

50
Common Resources

• Quotas
• By setting a production quota at the efficient
  quantity, a common resource might remain in
  common use but be used efficiently.
• Figure 16.8 shows this situation.
• It is hard to make a quota work.

51
(No Transcript)
52
Common Resources

• Individual Transferable Quotas
• An individual transferable quota (ITQ) is a
  production limit that is assigned to an
  individual who is free to transfer the quota to
  someone else.
• A market in ITQs emerges.
• If the efficient quantity of ITQs is assigned,
  the market price of an ITQ confronts resource
  users with a marginal cost that equals MSB at the
  efficient quantity.

53
Common Resources

• Figure 16.9 shows the situation with an efficient
  number of ITQs.
• The market price of an ITQ increases the marginal
  cost to MC1.
• Users of the resource make marginal private
  benefit, MB, equal to marginal private cost, MC1,
  and the outcome is efficient.

54
(No Transcript)
55
Common Resources

• Public Choice and Political Equilibrium
• It is easy for economists to agree that ITQs make
  it possible to achieve an efficient use of a
  common resource.
• It is difficult to get the political marketplace
  to deliver that outcome.
• In 1996, Congress killed an attempt to use ITQs
  in the Gulf of Mexico and the Northern Pacific
  Ocean.
• Self-interest and capture of the political
  process sometimes beats the social interest.

56
THE END