Chapter 3 - Public Goods

Chapter 3 - Public Goods
Public Finance
1
Public Goods Defined
• Pure public goods share two

characteristics
– Nonrival – Cost of another person consuming
the good is zero
– Nonexcludable – Very expensive to prevent
others from consuming the good
2
Examples of Public and Private Goods
• Public Goods • Private goods

– National defense – Pizza
– House cleaning in an – Health care
apartment with many – Congested freeway
roommates
– Public housing
– Fireworks display
– Music file sharing
– Uncongested freeway
3
Valuation of Public Goods
• Everyone consumes same quantity of

public good
• Marginal benefit of public good varies by
person
– In the housecleaning example, different
roommates value the clean apartment
differently.
4
Impure Public Goods
• Most goods that are thought of as public

goods may not strictly satisfy the nonrival
or nonexcludable assumption.
– A scenic view is a public good without
congestion, but the quality diminishes as
more the number of sightseers increases.
– Thus, a scenic view becomes rival.
5
Private Goods can Be Provided
by the Public Sector
• These are called “publicly provided private

goods.”
• Key criteria: is the good rival and excludable?
• Public housing is rival (one family consumes
one apartment) and excludable (easy to
prevent consumption).
6
Figure 3.1
Equilibrium in Private Goods Market
• Equilibrium where supply curve intersects

aggregate demand curve
• Everyone pays the same price, P
• Individuals consume different quantities,
Q
• Pareto efficient
8
Figure 3.4
Efficiency in Public Goods Market
• Everyone consumes the same quantity,

Q.
• Individual’s marginal benefit varies.
• Efficiency requires that the sum of
individual marginal benefits equals the
marginal cost.
10
Numerical Example
• Consider 2 individuals, Adam and Eve, who
have the following inverse demand curves and
face a marginal cost curve below.
1
PA  100  Q A
2
PE  200  Q E
2
M C  Q
3
11
Numerical Example, Private Good
• If the good was a private good, then the

aggregate demand curve is:
Q  Q A  Q E  (200  2 P A)  (200  P E)
• With a private good, everyone pays the same

price.
P  PA  PE
Q  400  3P
12
Numerical Example, Private Good
• In a competitive market, P=MC
400 Q 2
P  M C    Q
3 3 3
400 800
Q   1 3 3, P   88
3 9
• Approximately 133 units of the private good are provided at a price of
$88.
• Adam consumes around 22 units, and Eve consumes around 111 units.
13
Numerical Example, Public Good
• Suppose instead that the good is a public

good. The aggregate demand curve is:
1
P  P A  P E  (1 0 0  Q A )  (200  Q E )
2
• With a public good, everyone consumes the
same quantity.
Q  Q A  Q E
3
P  300  Q
2
14
Numerical Example, Public Good
• Efficient provision would require: P=MC
3 2
P  M C  300  Q  Q
2 3
Q  1 3 8 .4 6 , P  9 2 .3 0
• Efficient provision would imply that Adam & Eve
consume 138.46 units of the public good.
• Private market may not arrive at this allocation, however.
15
Efficient Allocations of Public Goods:
Problems
• Although a competitive market will provide

private goods efficiently, will the same be true
for public goods?
• People may have incentives to hide their true
preferences for a public good.
• If Adam can get Eve to pay for the public good,
he can use his income for other purposes and
still enjoy the public good.
16
Problems, continued
• This incentive to let others pay for the

public good while still enjoying the
benefits is known as the “free rider
problem.”
• The private market may therefore fall
short of providing the efficient amount of
the public good.
17
Problems, continued
• This incentive to free ride occurs

because the public good is nonrival and
nonexcludable.
• A person gets to consume the good even
if he does not pay for it.
18
Problems, continued
• Return to the public goods numerical example. Suppose

Adam chooses to free ride, and Eve therefore provides her
optimal amount.
• Eve chooses:
PE  M C  Q E  Q  120
• After Eve contributes 120 units of the public good, Adam does
not provide any additional contributions, because the marginal
benefit to Adam of the 120th unit is less than the marginal cost.
19
Solutions to the Free Rider Problem
• Government intervention can potentially lead to a more

efficient outcome.
– Government can use coercive power to force people to
pay for public goods, through taxation.
• Free riding is not a fact, however. There are instances
when individuals do act collectively without coercion.
• Laboratory experiments on college students contradict
the notion that free riding will lead to zero contributions
for the public good. Some suggest the results derive
from a “warm glow” of giving.
20
Privatization Debate
• Privatization means taking services that are

supplied by the government and turning them
over to the private sector for provision and/or
production.
• Examples with competing public/private
provision include policing, parks, and even the
judicial system.
21
Private Provision
• Mix of private and public provision depends on:

– Relative wage and materials costs: Which sector is less
expensive?
– Administrative costs: Can these fixed costs be spread
over a large group of people?
– Diversity of tastes. Private provision is more efficient
with diverse tastes because people can tailor their
consumption to their own tastes.
– Distributional issues. Notions of fairness may require
that some commodities are available to everyone – such
as education or health care.
22

Chapter 3 - Public Goods

Uploaded by

Copyright:

Available Formats

Chapter 3 - Public Goods

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Chapter 3 - Public Goods

Uploaded by

Copyright:

Available Formats

Chapter 3 - Public Goods

• Pure public goods share two

• Public Goods • Private goods

• Everyone consumes same quantity of

• Most goods that are thought of as public

• These are called “publicly provided private

• Equilibrium where supply curve intersects

• Everyone consumes the same quantity,

• If the good was a private good, then the

• With a private good, everyone pays the same

• In a competitive market, P=MC

• Suppose instead that the good is a public

• Efficient provision would require: P=MC

• Although a competitive market will provide

• This incentive to let others pay for the

• This incentive to free ride occurs

• Return to the public goods numerical example. Suppose

• Government intervention can potentially lead to a more

• Privatization means taking services that are

• Mix of private and public provision depends on:

You might also like