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Demand, Supply and Market Equilibrium. Lecture 3. Markets. A market is an institution or mechanism that brings together buyers (demanders) and sellers (suppliers) of particular goods and services - PowerPoint PPT Presentation
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McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
CHAPTER 4
Public GoodsPublic Goods
4-2
Characteristics of Goods
Excludable v Nonexcludable Excludable – preventing anyone from consuming the
good is relatively easy Nonexcludable – preventing anyone from consuming the
good is either very expensive or impossible
Rival v Nonrival Rival – once provided, the additional resource cost of
another person consuming the good is positive Nonrival – once provided, the additional resource cost of
another person consuming the good is zero
4-3
Types of Goods
EXCLUDABLE
RIVALYES NO
YES
NO
PRIVATE
GOODS
PUBLIC
GOODS
COMMON
RESOURCES
NATURALMONOPOLY
4-4
Noteworthy Aspects of Public Goods
Even though everyone consumes the same quantity of the good, it need not be valued equally by all
Examples?
4-5
Noteworthy Aspects of Public Goods
Classification as a public good is not absolute; it depends on market conditions and the state of technology
Consider a lighthouse – pure public good Jamming device preventing ships from obtaining the
lighthouse signal unless special receiver purchased (excludable)
A scenic view, as congestion rises, nonrivalness criterion no longer satisfied impure public good: is to some extent rival or
excludable
4-6
Noteworthy Aspects of Public Goods
A commodity can satisfy one part of the definition of a public good but not the other
Main roads in rush house: nonexcludability holds but consumption is rival. Everyone is trying to get ahead
Exclusion is possible if there are only a few access roads
4-7
Noteworthy Aspects of Public Goods
Some things that are not conventionally thought of as commodities have public good characteristics
Honesty – transactions costs Fairly distributed income Information dissemination
4-8
Noteworthy Aspects of Public Goods
Private goods are not necessarily provided exclusively by the private sector publicly provided private goods Medical services Housing
4-9
Noteworthy Aspects of Public Goods
Public provision of a good does not necessarily mean that it is also produced by the public sector
Government can contract out to private firms for the provision of certain public goods
Garbage collection Fire protection
4-10
Some Other Public Goods
Basic research Programs to fight poverty Uncongested nontoll roads Fireworks display
4-11
Efficient Provision of Private Goods
Horizontal summation for finding the market curve Price Adam
(DfA)
Eve (Df
A)Market (Df
A+E)$11 5 1 6
$9 7 3 10
$7 9 5 14
$5 11 7 18
$3 13 9 22
$1 15 11 26
4-12
0
1
2
3
4
5
6
7
8
9
10
11
12
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26
DfA
DfE
DfA+E
Sf
$
Quantity of Pizza
4-13
Pareto Efficiency – Private Goods Case
MRSfa = Pf/Pa (from IC and Budget line) Set Pa = $1 MRSfa = Pf
Price of figs measures the rate at which Adam is willing to substitute figs for apples
DfA shows MRSfa for Adam
Adams demand curve for figs shows the maximum price per fig leaf that he would pay at each level of fig leaf consumption
DfE shows MRSfa for Eve
4-14
Pareto Efficiency – Private Goods Case
Supply (Sf) shows MRTfa
MRTfa = MCf/ MCa Let MCa =1, so MRTfa = MCf
Therefore in pure competition Pf = MCf (Pareto Efficient) Necessary condition for Pareto efficiency:
MRSfaAdam = MRSfa
Eve = MRTfa
4-15
Efficient Provision of Public Goods
Are fireworks a public good or private good? Nonrival? Nonexcludable?
Units of Fireworks
1 2 3 4
Adam (DrA) $300 $250 $200 $150
Eve (DfE) 250 200 150 100
Market(Df
A+E)$550 $450 $350 $250
4-16
Once again, prices are being interpreted in terms of MRS as Adam’s willingness to pay for rockets is his MRS
From production standpoint, price represents the MRT
4-17
The MB of the fourth unit is the sum of what Adam and Eve are willing to pay, which is $250
The MC of the fourth unit is the cost of the last unit
If the MB>MC then it should be produced “Provision of public goods should be
expanded until the point at which the sum of each person’s marginal valuation of the last unit just equals the MC”
4-18
Market Demand for Public Goods
Public goods must be consumed in equal amounts, no matter how differently Adam and Eve value each unit
Market demand is the sum of willingness to pay by each consumer for a given quantity
So, instead of horizontal summation, it is vertical summation
4-19
050100
150200250300350400
450500550600650
700750800
1 2 3 4
DrA
DrE
DrA+E
Sr
Quantity of Fireworks
$
4-20
Pareto Efficiency – Public Goods Case
MRSfa = Pf/Pa
Set Pa = $1 MRSfa = Pf
DfA shows MRSfa for Adam
DfE shows MRSfa for Eve
Sf shows MRTfa
Necessary condition for Pareto efficiency: MRSfa
Adam + MRSfaEve = MRTfa
4-21
Private Good: MRS (Adam)= MRS(Eve) = MRT Public Good MRS (Adam) + MRS(Eve) = MRT Since everyone consumes the same amount of
public good, its efficient provision requires that the total valuation they place on the last unit provided (sum of MRS) equal the incremental cost to society of providing it (MRT)
4-22
Problems Achieving Efficiency
No incentive to lie about how much you value a private good!
The Free-Rider Problem
Someone who lets other people pay while enjoying the benefits himself
Excludable consumption, but nonrival
Eg. Fireworks display cannot be seen w/o purchasing a ticket. Anyone willing to pay more than 0 can buy ticket. What should you charge?
4-23
Solutions to the free-rider problem Perfect price discrimination
A nonrival excludable commodity can be provided privately in case of perfect information
Policy Perspective: Global Positioning System (US military initially did not want civilians to benefit from GPS)
Do people free ride?
4-24
Laboratory Experiments and Free-Riding
How a typical experiment works Typical results
People contribute about 50% of resources to provision of public good
Contributions fall the more often the game is repeated Cooperation fostered by prior communication Contribution rates decline when opportunity cost of
giving goes up
“Warm-glow” feeling of satisfaction from giving giving
4-25
The Privatization Debate
Privatization – taking services supplied by government and turning them over to the private sector
Public v Private Provision: What is the right mix? Relative wage and materials costs Administrative costs Diversity of tastes
4-26
Public versus Private Production
Efficiency of private production Problems in comparing cost differences Incomplete Contracts Competition to supply good or service Reputation building Policy Perspective: Should airport security be
produced publicly or privately? Market Environment
4-27
Distributional Issues
Commodity egalitarianism – notion that some commodities ought to be made available to everyone
4-28
Appendix: Preference Revelation Mechanisms
∆TEve = MRTra – (MRSraTotal – MRSra
Eve)
Eve’s choice: ∆TEve = MRSraEve
By substitution: MRTra – (MRSra
Total – MRSraEve) = MRSra
Eve
Add (MRSraTotal – MRSra
Eve) to both sides:
MRTra = MRSraTotal