17.3 Public Goods

1. 17.3 Public Goods • What is a Public Good? • Efficient Provision of Public Goods • The Efficiency Conditions • Private Provision of Public Goods • Free-Riders • Privatization

2. Theory - What is a Public Good? A PURE PUBLIC GOOD has two features: • Nonrival – once provided, another person can consume it at no additional cost • Nonexcludable (nonexclusive) – once provided, it is impossible or highly expensive to prevent anyone from consuming it

3. Pure Public Good Examples National Defense is a good example of a pure public good: • Nonrival – all Canadians benefit • Nonexcludable – it’s impossible to prevent a Canadian from benefitting Other examples: Conventional Radio, A Beautiful View, A Canada-Wide Sunglass dome designed to block harmful sun rays (Canadome)

4. What is a Private Good? A PRIVATE GOOD has two features: • Rival – once consumed, another person cannot consume it • Excludable (exclusive) – others can be prevented from consuming it Food (ie: pizza or sushi) is a good example of a private good. Once I eat it, it’s gone. (YUM!)

5. Pure Public Good Issues 6 Issues arise out of Pure Public Goods: • Different Values • Public Goods Aren’t Absolute • NONRIVAL ≠ NONEXCLUDABLE • Unconventional Public Good • Private Provision • Private Production

6. 1) WHILE EVERYONE CONSUMES THE SAME AMOUNT, PEOPLE MAY VALUE IT DIFFERENTLY -National defense protects everyone equally. Paranoid people love it and peace activists hate it. -The Canadome is popular among people concerned with cancer and unpopular with people wanting tans. It affects everyone, however

7. 2) PUBLIC GOODS ARE NOT ABSOLUTE -technology and the market can affect a public good. A free TV station becomes private if you need a decoder. A beautiful view becomes rival if there is a crowd. -An IMPURE PUBLIC GOOD is to some extent rival or to some extent excludable -most public goods are impure, but analysis of pure public goods still gives valuable results for impure public goods

8. 3) NONRIVAL ≠ NONEXCLUDABLE -National parks are excludable if they have gates, but practically nonrival as they are so big -My office hours are nonexcludable, as everyone is welcome, but rival if too many people are waiting in line -Therefore many public goods are impure public goods

9. 4) VARIOUS THINGS HAVE SIMILARITIES WITH PUBLIC GOODS -Inspiration can be nonrival and nonexcludable (such as coming from a sunset) -Fear is nonrival, as one person being afraid doesn’t prevent others. Fear is also nonexcludable, as its hard to prevent. -Income distribution or honesty are public goods as everyone benefits

10. 5) THE PUBLIC SECTOR CAN PROVIDE PRIVATE GOODS -Medical services, housing, licenses, and utilities can all be provided by the government and/or private sector -The label public or privatedoesn’t indicate what sector provides the item

11. 6) PUBLIC PROVISION ≠> PUBLIC PRODUCTION -Some public services are contracted out to private contractors -For example, the City of Edmonton contracts out much of its snow removal business -it provides the public service through private contractors

12. Efficient Provision of Private Goods -To cover efficient provision of public goods, we first look at efficient provision of private goods -Consider Maka and Susan’s individual demands for video games -At a market price, we add up Maka and Susan’s quantity demanded for video games to find market demand -This results in a HORIZONTAL SUMMATION

13. Efficient Provision of Private Goods: Maka Susan Market demand P P P 100 40 Q Q Q 2 5 7 @ P=$40, QM+QS=QD 2+5=7

14. Efficient Provision of Private Goods: When market supply intersects market demand, we find equilibrium price and individual demand. Maka Susan Market P P P S 100 65 40 Q Q Q 2 3.5 5 Q*=5 7 1.5 @ P*=$65, QM+QS=Q* 1.5+3.5=5

15. Efficient Provision of Private Goods -From microeconomic theory, we know that a consumer maximizes utility where MRSxy=Px/Py -If we normalize Py to $1, this simplifies to MRSxy=Px -Since price is found on the demand curve, Maka’s (Susan’s) demand expresses Maka’s (Susan’s) MRS at each level of consumption

16. Efficient Provision of Private Goods -From microeconomic theory, the supply curve comes from MC -MRTxy=MCx/MCy, but since Py=MCy and Py=$1, MRTxy=MCx -therefore the supply curve represents MRTxy Then, at equilibrium, Supply=Demand, and Pareto Efficiency Condition

17. Efficient Provision of PUBLIC GOODS -Consider Maka and Susan’s individual demands for a public good: youtube cooking shows -youtube is nonrival and nonexcludable; one person’s consumption doesn’t affect the other -The key difference in a public good is that BOTH can consume a purchased good; it is not used up -This results in a VERTICAL SUMMATION to calculate willingness to pay

18. Efficient Provision of Public Goods: Market demand Maka Susan P P P 11 10 7 4 Q Q Q 2 2 2 Maka is willing to pay $4 each for 2 youtube shows, and Susan is willing to pay $7 each, therefore the market is willing to pay $11 each

19. Efficient Provision of Public Goods: Market demand Maka Susan P P P S 11 10 7 6 4 4 2 Q Q Q 2 3 2 3 3 The market Supply gives an equilibrium quantity of 3. Here price paid in the market ($6) is the sum of Maka’s payment ($2) and Susan’s payment ($4).

20. Efficient Provision of Public Goods -Once again, if we normalize our other good to $1, demand (willingness to pay) represents MRS for each person. -The sum of both people’s willingness to pay (market demand), is therefore the sum of individual MRS. -The supply curve still represents MC and therefore MRT, so we have:

21. Efficient Provision of Public Goods -Furthermore, again since Py=$1, -Intuitively, public goods should therefore be provided until the point where the marginal cost of the good is equal to the sum of marginal benefits -The private good equation can also be rewritten as

22. Public Goods Conclusion In short, public goods are always best provided where Total Marginal Benefit = Marginal Cost

23. Calculating Public Good Demand • Solve each demand for P • Find where P=0 to find cut-off points. • Add together applicable demand curves between cut-off points.

24. Calculating Public Good Equilibrium A) Equate S=D in multiple pieces of demand function -When solved Q* value lies in the appropriate range, it is valid B) Use individual demand to calculate each person’s price (negatives are zero)

25. Public Good Example Rick and Shane decide to buy some fireworks to cheer up the survivors of the Zombie apocalypse. Their demand curves and firework supply are:

26. Public Good Demand Example

27. Public Good Demand Example

28. Public Good Equilibrium Example

29. Public Good Equilibrium Example Rick will pay $42.20 and Shane will pay $35.60 for 57.8 fireworks…. Which attracts the zombies, who eat everyone… Which is good for the zombies?

30. Public Good Example: Market demand Shane Rick P P P S 77.8 42.20 35.6 Q Q Q 57.8 57.8 57.8 Shane and Rick both put money towards the public good, which everyone enjoys (until they’re eaten).

31. Theory - Private Provision of Public Goods If a public good is provided privately, its efficiency depend on how people represent their willingness to pay -For private goods, people have no incentive to misrepresent their willingness to pay -if the price is $10, and that lies in their willingness to pay, they will pay the $10, consume the good and be happy

32. Private Provision of Public Goods -For public goods, people have an incentive to misrepresent their willingness to pay -if the price is $10, a person could hope someone else pays the price, then they get to enjoy it (they are a FREE RIDER) -for example, at an alligator reserve, people can pay money to throw meat into the water and watch the alligators go, and often wait for someone else to buy and throw the meat

33. Private Provision of Public Goods -If the public good can be made excludable (ie: entrance fee), it is still provided inefficiently, as the MC of an additional consumer is zero, therefore P>MC -The one way to avoid the free rider problem is through PERFECT PRICE DISCRIMINATION – everyone pays their willingness to pay -this requires full information, therefore private provision is often doomed to be inefficient

34. The Free Rider Problem THE FREE RIDER PROBLEM comes from the incentive to let others pay while you enjoy the benefits -Yet empirically, people do band together to raise funds for public goods such as libraries -This typically only happens when the number of contributors are small and everyone can see their impact -Therefore government intervention is often needed for public goods

35. Public Production Debate The argument about who should PRODUCE public goods (government or private) often hinges on two concepts: Cost vs. Quality -private companies often produce inferior products (as in US health insurance refusing coverage or charging high premiums) -private companies often have lower costs due to a focus on profit and lack of unions

36. Production Debate Some argue that quality can be maintained through good contracts -Some contracts are straightforward: cut the park lawn once a week -Some contracts are near impossible: treat this yet-to-be-discovered disease with the following yet-to-be-discovered drugs

37. Production Debate Market structure also needs to be considered: -If the government has a monopoly, is lack of competition causing inefficiency? -If privatization creates a monopoly or oligopoly, will market power cause inefficiency?

38. Case Study: Alberta Liquor Privatization West (1997) studied the 1993 privatization of Alberta liquor stores and learned the following: -the number of liquor stores rose from 258 to 604, and although selection and individual stores fell, overall selection increased -liquor prices rose between 8.5% and 10% (compared to 5% inflation)

39. Case Study: Alberta Liquor Privatization -Liquor store employment tripled as wages fell by up to 50% (the union was replaced) -There was no evidence of increased alcohol consumption or alcohol-related crimes

40. Case Study: Alberta Liquor Privatization Was privatization good? More stores vs. poorer selection Liquor Price Increases More employment vs. Lower wages If this privatization is so complex, what does that say about privatizing healthcare, utilities or schools?

41. Chapter 17 Summary • Externalities occur when one agents actions affect another outside market mechanisms • Externalities cause P≠SMC, causing inefficiency • Externalities can be dealt with privately through: • Assigning property rights (Coase Theorem) • Mergers • Social Conventions

42. Chapter 17 Summary • The government can deal with externalities through: • Pigouvian Taxes • Pigouvian Subsidies • Permits and a market • Regulation • Taxes and Permits are generally most efficient and effective

43. Chapter 17 Summary • All public methods to address negative externalities suffer from: 1) the difficulty in measuring externalities 2) possible redistribution issues • Positive externalities can be dealt with through subsidies • These can be hard to measure • Financing subsidies can be distortionary • This may effect equitable distribution

44. Chapter 17 Summary • Public goods are nonrival and nonexcludable • Public Goods are efficiently provided where ∑MRS=MRT or ∑MB=MC • (Private goods are efficiently provided where MRSA = MRSB = MRT) • Efficient provision occurs where Total Benefit = Total cost • It is unlikely that markets would provide public goods efficiently, even if they are excludable

45. Chapter 17 Summary • Free-riding limits private provision of public goods • Two issues with production of public goods are efficiency and quality • Econ 384 had great students. Your professor had a lot of fun teaching this course.