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Public Goods and Common Resources

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16 CHAPTER Public Goods and Common Resources After studying this chapter you will be able to Distinguish among private goods, public goods, and common resources ... – PowerPoint PPT presentation

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Title: 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.

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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.

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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.

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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.

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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.

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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.

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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
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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
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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.

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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.

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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.

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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
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