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Public Goods

Public Goods. Normative and Positive Perspective. Plan. Review: The First Welfare Theorem Public Goods definitions, examples practical problems with providing public goods. The First Welfare Theorem . If producers and consumers act as price takers; there is a market for every commodity;

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Public Goods

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  1. Public Goods Normative and Positive Perspective

  2. Plan • Review: The First Welfare Theorem • Public Goods • definitions, examples • practical problems with providing public goods

  3. The First Welfare Theorem • If • producers and consumers act as price takers; • there is a market for every commodity; • all the commodities are rival and excludable; • consumers’ preferences and technology are “well-behaved” • Then a market allocation is Pareto Efficient.

  4. Public Goods • Public goods are • non-rival (use of a unit by one agent does not preclude its use by the other agents); • non-excludable (it is impossible to prevent anyone in a community from enjoying it) • Examples • defense, software (“know-how”), lighthouse, radio, clean air, parks, highways

  5. Impure Public Goods • Some goods can be viewed non-rival as long as few are using them. Congestion may reduce the benefits to the users as their number grow large. • Examples: parks, highways, swimming pools. • Some goods can be restricted for use only by the members of a certain community. • Examples: swimming pools, software. • Remark: Honesty is NOT a public good.

  6. Public Goods and a Government • There are privately produced public goods: sanitation, fire protection, police • There are publicly produced private goods: housing, medical care • Thus, provision of public goods is not the one and only prerogative of a government

  7. The “Free rider” Problem • An Example • Adam and Eve can make a firework if they contribute $10 to buy it from a store. If the money collected is more than the cost, than the surplus will be divided equally between Adam and Eve. • Adam and Eve have to announce how much are they willing to pay for the firework. • Adam values fireworks at 7 and Eve values it at 4. Each one knows his own valuation and does not know the valuation of the other.

  8. Revelation of Preferences

  9. The Outcome • Whatever Eve says, it is better for Adam to underestimate his willingness to pay. • Whatever Adam says, it is beneficial for Eve to underestimate as well. • As a result, there will be no fireworks, although together they are willing to cover its cost.

  10. How to make them tell the truth? • Suppose now that the rules of the game are different. • Both Adam and Eve still have to announce their valuations. The fireworks will be provided as long as the sum of their valuations is above the cost • But each one pays the cost of the fireworks, $10, minus the announced valuation of the opposite player.

  11. The Revelation Game

  12. The Outcome • Adam and Eve enjoy the fireworks • But the “budget” is not balanced, i.e., somebody has to pay (subsidize) the provision of the public good.

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