Public Goods and Common Resources

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CHAPTER
Public Goods and Common Resources
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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

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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?

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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.

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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.

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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.

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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.

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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.

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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.

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Classifying Goods and Resources

• Figure 16.1 shows this four-fold classification
  of goods and services.

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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.

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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.

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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.

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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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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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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.

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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.

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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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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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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.

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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.

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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.

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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).

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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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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.

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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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).

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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.

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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.

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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.

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Common Resources
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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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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)

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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.

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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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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.

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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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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.

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THE END