Professor Jane Leuthold

1
Characteristics of Public Goods

• Professor Jane Leuthold
• Department of Economics
• University of Illinois

Economics 214
2
Agenda for today ...

• What is a public good?
• In theory, what is the efficient level of public
  good provision?
• Why do public goods cause markets to fail?
• Investment experiment

3
How are a levee and a pizza alike?

• They both benefit people
• They are both costly to produce
• They each benefit some people more than others

4
How are a levee and a pizza different?

• A levee protects everyone from the flood. One
  persons protection does not prevent anyone else
  from enjoying the protection of the levee. A
  pizza, once consumed by one person, cannot be
  consumed by anyone else.
• Once the levee is built, people cannot be easily
  excluded from the protection of the levee. People
  who refuse to pay can be easily excluded from the
  benefits of the pizza.

5
Characteristics of public goods

• Nonrival in consumption a given quantity of a
  public good can be enjoyed by more than one
  consumer without decreasing amounts enjoyed by
  rival consumers
• Nonexclusion it is too costly to develop a
  means of excluding those who refuse to pay from
  enjoying the benefits of a given quantity of the
  public good

6
Examples of public goods

• National defense
• Foreign aid
• Research
• Food safety standards
• Local streets
• City parks

7
What is the cost of a public good?

• Cost of provision (below left)
• Cost of production (below right)

200
Marginal Cost of Production
Marginal Cost of Provision
1
Number of Consumers
Units of a pure public good per year
8
Continuum of goods
Pure Private
o Pizza
o National parks
o TV programming
Exclusion
o City parks
o Levees
Pure Public
Rivalry
9
Semipublic goods

• Congestible public goods -- crowding reduces the
  benefits to existing consumers when more
  consumers are accommodated (streets and parks)
• Price-excludable public goods -- have benefits
  that can be priced (music performed indoors)

10
Congestible public good

• Some goods are consumed collectively up to the
  point of congestion
• Do you think congestion will be a problem for the
  Fighting Illini this year?

MB
Marginal congestion cost per user
Illini fans
11
Efficient pricing and provision of a congestible
public good

• What is the efficient number of tickets?
• What price should be charged per ticket to assure
  efficiency?
• What should be the price of tickets in the
  absence of congestion?

MB
Marginal congestion cost per user
Illini fans
ZERO!
12
Price-excludable public good

• Television transmissions is a price-excludable
  public good. How are viewers excluded?
• What is the efficient number of viewers?
• When tv transmissions are financed by cable, why
  is the outcome inefficient?

D
V
Number of Viewers
TOO FEW VIEWERS!
13
Demand for public goods

• How do we construct a demand curve for a public
  good and determine the efficient level of public
  good provision?
• Lets start by constructing the demand curve for
  a private good.

14
Demand for pizza
P
MC S
DP
DM
Pizzas
Q represents the efficient output of pizzas.
Why?
15
Demand for public goods

• The demand curve for a private good is
  constructed by summing the individual demands
  horizontally.
• Efficiency is determined where demand equals
  supply.
• With a public good, all individuals consume the
  same quantity of the public good, so individual
  demands can no longer be summed horizontally.

16
Demand for a levee
MB
MC S
MBM
MBP
Height of levee
H represents the efficient height for the levee.
Why?
17
Demand for public goods

• The demand curve for a public good is constructed
  by summing the individual demands vertically.
• Efficiency is determined where marginal benefit
  equals marginal cost.
• Suppose everyone is asked to contribute
  voluntarily to the public good.

18
Voluntary contributions
If M contributes tM H and P contributes tP H,
then together the contributions will cover the
cost of the levee at the optimal height, H.
P
MB
MBP
E
MBM
MC
TOTALCONTRIBUTION
tP
PS CONTRIBUTION
tM
MS CONTRIBUTION
H
Height of the levee
19
Lindahl equilibrium
P
MB
MBP
E
MBM
MC
H
Height of the levee
20
Lindahl prices

• If the Lindahl prices were known, and could be
  assigned to each consumer, all individuals would
  unanimously agree on the efficient quantity of
  the public good.
• Unfortunately, individuals are not likely to
  reveal their Lindahl prices when asked. Why not?
• This causes the market for public goods to fail
  and generally requires government provision of
  public goods.

21
Problem
MB MC

• Suppose two persons have identical preferences
  for a public good. If MC 20, what is the
  efficient level of the public good? What are the
  Lindahl prices?

20
MBAMBB
20
Public good
MB 40 - 2Q MC 20 MBMC Q 10 tA
tB 10
22
Soap Box
The Champaign Public Works Department is studying
the problem of congestion in campustown and will
propose a solution soon.  For the Soap Box this
week, suggest your own solution to the problem of
congestion in campustown.  If your solution is to
provide more parking, be sure to suggest how the
additional parking should be funded.  Help out
the Public Works Department with your good
economic suggestions.  
23
Investment Experiment

• Asset A pays you a fixed return of 5 on your
  investment
• Asset B pays a return of 10 on the total class
  investment, to be divided equally among all
  students in the class

You have 100 (hypothetical) to invest in one or
both of these assets. Note on the handout how
you would like to divide your investment between
the two assets and answer the questions at the
bottom of the handout.
24
Next time ...
Thursday Free Rider Problem and Public
Goods Ch. 4 (155-161)