Public Goods and Common Resources

1. 11 Public Goods and CommonResources

2. The Different Kinds of Goods • Public goods & Common resources • Not excludable: people cannot be prevented from using them (free riders) • Externalities • Public Good: positiveexternality/benefits for the public, but not compensated for in market • SMB > PMB -> 2 different demand curves • Produce too little when PMB = PMC (Market) • Common property resource: negative externality/costs • PMC < SMC -> 2 different cost curves • Overuse of the resource

3. Criteria Use For Classifying Goods • Excludability – can people be excluded from using the good it they don’t pay for it? • Public Goods (e.g., Fire Station) – NO! • Common Property (e.g., Parks, Fishery) – NO! • Rivalry in consumption • One person’s use diminishes other people’s use • Public Goods – No, one individual’s use does not reduce the amount available to others • Common Property – Yes! (Trees, Fish)

4. Public Goods & Common Property Resources • The free-rider problem (can’t exclude) • Free rider • Person who receives the benefit of a good but avoids paying for it • Public goods – not excludable/non-rival • Once resource is provided, difficult to exclude others from benefitting (and making them pay) for it (e.g., fire station, national defense) • Private market won’t provide enough (economically efficient amount)

5. 3 Education and the social optimum Price of Aluminum External Benefit Equilibrium Optimum Supply (private cost) Social value (private value and external benefit) QMARKET QOPTIMUM 0 Quantity of Aluminum In the presence of a positive externality, the social value of the good exceeds the private value. The optimal quantity, QOPTIMUM, is therefore larger than the equilibrium quantity, QMARKET. Demand (private value)

6. Public Goods & Common Property Resources • Common Property Resource – also not excludable, but is rival in consumption • Can’t exclude others from using/accessing the resource (fish, timber/forests) -> leads to overuse and possible exhaustion of the resource

7. The Different Kinds of Goods • Types of goods • Public goods • Not excludable & Not rival in consumption • Common resources • Rival in consumption & Not excludable • Private goods • Excludable & Rival in consumption • Natural monopoly • Excludable & Not rival in consumption

8. Public Goods • Some important public goods • National defense • Very expensive public good • Basic research • General knowledge • Fighting poverty • Welfare system • Food stamps • Education

9. 3 Education and the social optimum Price of Aluminum External Benefit Equilibrium Optimum Supply (private cost) Social value (private value and external benefit) QMARKET QOPTIMUM 0 Quantity of Aluminum In the presence of a positive externality, the social value of the good exceeds the private value. The optimal quantity, QOPTIMUM, is therefore larger than the equilibrium quantity, QMARKET. Demand (private value)

10. Correcting for Positive Externalities

11. Externalities and Market Inefficiency • Positive externalities • Socially optimal quantity • Greater than market equilibrium quantity • Government – correct market failure • Internalize the externality • Subsidy

12. Effect of a “corrective” subsidy

13. Public Goods • The free-rider problem • Public goods – not excludable, non-rival • Free-rider problem prevents the private market from supplying the economically efficient (SMC = SMB) amount of the good • Government - can remedy the problem • If total benefits of a public good > its costs • Provide the public good (or subsidize it) • Pay for it with tax revenue • Make everyone better off

14. Correcting for Externalities • Subsidizing “clean fuels” • Alternative to taxing “dirty” fuels • Help individuals realize external benefits • Finance and/or subsidize production and consumption of the good • Overall consumption is increased, illustrated by a rightward shift in demand • But have to pick the “right fuels” • “What would the market do?” • Subsidize research in new energy

15. Are lighthouses public goods? • Decide whether something is a public good • Determine who the beneficiaries are • Determine whether the beneficiaries can be excluded from using the good • A free-rider problem • When the number of beneficiaries is large • Exclusion of any one of them is impossible

16. Public Goods • The difficult job of cost–benefit analysis • Government • Decide what public goods to provide • In what quantities • Cost–benefit analysis • Compare the costs and benefits to society of providing a public good • Doesn’t have any price signals to observe • See Harris • Government findings on the costs and benefits • Rough approximations at best

17. How much is a life worth? • Cost: $10,000 – new traffic light • Benefit: increased safety • Risk of a fatal traffic accident • Drops from 1.6% to 1.1 % • Obstacle • Measure costs and benefits in the same units • Put a dollar value on a human life • Priceless = infinite dollar value

18. How much is a life worth? • Put a dollar value on a human life • Implicit dollar value • Courts - award damages in wrongful-death suits • Ignores other opportunity costs of losing one’s life • Risks - people are voluntarily willing to take • Value of human life = $10 million • Cost-benefit analysis • Traffic light • Reduces risk of fatality by 0.5 percentage points • Expected benefit = 0.005 × $10 million = $50,000 • Cost ($10,000) < Benefit ($50,000) • Approve the traffic light

19. The Different Kinds of Goods • Types of goods • Public goods • Not excludable & Not rival in consumption • Common resources • Rival in consumption & Not excludable • Private goods • Excludable & Rival in consumption

20. 1 Four types of goods Goods can be grouped into four categories according to two characteristics: (1) A good is excludable if people can be prevented from using it. (2) A good is rival in consumption if one person’s use of the good diminishes other people’s use of it. This diagram gives examples of goods in each category.

21. Why the cow is not extinct • Species of animals • Public Goods • Have a commercial value - threatened with extinction • Buffalo • North America • Hunting to near extinction - 19th century (from trains) • Elephants (Ivory) • African countries • Hunting – today • Private good • The cow • Commercial value • Species - continue to thrive

22. Why the cow is not extinct • Elephant - common resource • No owners • Poachers - numerous • Strong incentive to kill them • Slight incentive to preserve them • Cows - private good • Ranches - privately owned • Ranchers • Great effort to maintain the cattle population on his ranch • Reaps the benefit