Public Goods and Public Choice

1. Public Goods and Public Choice Chapter 16 © 2006 Thomson/South-Western

2. Introduction • Private goods have two important features: • They are rival in consumption – the amount consumed by one person is unavailable for others to consume • They are exclusive – suppliers can easily exclude those who don’t pay

3. Public Goods • Nonrival in consumption • One person’s consumption does not diminish the amount available to others • Once produced, public goods are available to all in equal amount • Marginal cost of providing the good to additional consumers is zero • Nonexclusive • Once a public good is produced, suppliers cannot easily deny it to those who fail to pay  it is nonexclusive • Because they are nonrival and nonexclusive, for-profit firms cannot profitably sell public goods

4. Classification of Goods • Quasi-Public goods • When not congested are non rival • Producers can with relative ease exclude non payers • Open-access goods • Rival but nonexclusive • Fish in the ocean are rival in the sense that once caught they are not available for others to catch • Nonexclusive in the sense that it would be costly or impossible for a private firm to prevent access to these goods

5. Exhibit 1: Categories of Private and Public Goods

6. Optimal Provision of Public Goods • Suppose the public good in question is mosquito control in a neighborhood, which, for simplicity, consists of only two houses • One is headed by Alan and the other by Maria • Alan spends a lot of time in the yard, thus values a mosquito-free environment more than does Maria

7. e Marginal cost $15 10 Dm 5 2 Exhibit 2: Market for Public Goods • Da and Dm are the demand curves reflecting the marginal benefits that Alan and Maria, respectively, enjoy at each rate of output • How much mosquito spraying should the government provide? • Suppose the marginal cost of spraying is a constant $15 an hour; the efficient level of output is 2 hours per week, where the marginal benefit to the neighborhood equals the marginal cost D Da Dollars per hour D 0 Hours of mosquito spraying per week

8. Optimal Provision of Public Goods • Efficient approach would be to impose a tax on each resident equal to marginal valuation • Once people realize their taxes are based on how much the government thinks they value the good, people tend to understate their true valuation • Taxpayers are reluctant to offer this information, creating what is called the free-rider problem • Even if the government had accurate information about marginal valuations, some households earn much more than others  a greater ability to pay taxes • Taxing people according to their marginal valuations may be efficient, but it may not be considered fair or equitable

9. Median-Voter Model • Voter whose preferences lie in the middle of the set of all voters’ preferences • The median-voter model predicts that under certain circumstances, the preference of the median, or middle voter will dominate other choices

10. Special Interest and Rational Ignorance • Households have neither the time nor the incentive to understand the effects of public choices on every product • They realize that each of them has only a tiny possibility of influencing the outcome of public choices

11. Special Interest and Rational Ignorance • Rational ignorance: voters remain largely oblivious to the costs and benefits of the thousands of proposals considered by elected officials • The cost to the typical voter of acquiring and acting on such information is usually greater than any expected benefits

12. Distribution of Costs and Benefits • Traditional public-goods legislation • Widespread benefits and widespread costs • Usually has a positive impact on the economy because total benefits exceed total costs • Special-interest legislation • Benefits are concentrated but costs widespread across nearly all consumers and taxpayers • Generally harms the economy, on net, because total costs often exceed total benefits

13. Distribution of Costs and Benefits • Populist legislation • Widespread benefits but concentrated costs • Difficult time getting approved because the widespread group that benefits typically remains rationally ignorant of the proposed legislation  voters provide little political support • Group adversely affected by costs will object • Competing-interest legislation • Involves both concentrated benefits and costs

14. Exhibit 3: Categories of Legislation Based on the Distribution of Costs and Benefits

15. Exhibit 4: Effects of Milk Price Supports • If Congress establishes a floor price of $2.50 per gallon, then the quantity supplied will increase and the quantity demanded will decrease • To maintain the higher price, the government must buy the excess quantity at $2.50 per gallon

16. Rent Seeking • Rents: government transfer or subsidy constitutes a payment to the resource owner that exceeds the earnings necessary to call forth that resource – payment exceeding opportunity cost • The activity that interest groups undertake to elicit these special favors from government is called rent-seeking

17. Rent Seeking • Shifts resources from productive endeavors that create output and income to activities that focus more on transferring income to the special interest • Do nothing to increase output • Frequently reduce output • Special interest groups compete for the same government advantage, so more resources wasted • If the advantage conferred by government requires higher income taxes, the net return individuals expect from working and investing will fall and they may work and invest less

18. Underground Economy • It is reasonably accurate to say that when government taxes productive activity, less production gets reported • The underground economy is a term used for all market activity that goes unreported to the government either to avoid taxes or because the activity itself is illegal

19. Underground Economy • A tax on productive activity has two effects: • Resource owners may supply less of the taxed resource because the after-tax wage declines • To evade taxes, some people will shift from the formal, reported economy to an underground, “off-the-books” economy • Tax avoidance is a legal attempt to arrange one’s economic affairs so as to pay the least possible tax • Tax evasion is illegal

20. Bureaucracy • Elected representatives approve legislation • The task of implementing legislation is typically left to bureaus

21. Ownership and Funding of Bureaus • Bureaus are typically financed by budget appropriation from the legislature, which comes from taxpayers • Becomes of the differences in the forms of ownership and in the sources of revenue, bureaus have different incentives than do for-profit firms so are likely to behave differently

22. Ownership and Behavior • Government bureaus receive less consumer feedback and have less incentive to act on any feedback they do receive • Government bureaus have less incentive to act on the information available • Profits or losses arising in the bureau are spread among all taxpayers, and because there is no transferability of ownership, bureaus have less incentive to satisfy customers or to produce their output using the least-cost combination of resources

23. Bureaucratic Objectives • The legislature has only limited ability to dig into the budget and cut particular items • If the legislature tries to cut the bureau’s budget, the bureau will threaten to make those cuts as painful to the legislature and constituents as possible • Budget maximization results in a larger budget than that desired by the median voter

24. Private versus Public Production • Simply because some goods and services are financed by the government does not mean that they must be produced by the government • Elected officials may also use some combination of bureaus and firms to produce the desired output • The trend is toward increased privatization  production by the private sector of government provided goods and services

25. Private versus Public Production • Legislators might prefer dealing with bureaus rather than firms for two reasons • The internal organization of the bureau may be more responsive to the legislature’s concerns than the manager of a firm would be • Bureaus provide legislators with opportunities to reward friends and supporters with government jobs