PPA 723: Managerial Economics Lecture 17: Public Goods The Maxwell School, Syracuse University Professor John Yinger

PPA 723: Managerial Economics

Lecture 17:

Public Goods

The Maxwell School, Syracuse UniversityProfessor John Yinger

Managerial Economics, Lecture 17: Public Goods

Outline

Definitions

Common Resources

Public Goods


Market Failure

Market power (e.g. monopoly) is a market failure that may call for government intervention.

Today we start a section on public goods and externalities, which lead to another kind of market failure that may call for government intervention—even in competitive markets.

We will look at both positive analysis (how do people behave with public goods and externalities) and normative analysis (the case for government intervention).


Definitions The topics in this section involve situations in

which people interact with each other. Externality = a case in which one person’s

actions inadvertently affect other people. Common Property = a case in which many

people consume a common resource. Public Good = a good that by its very nature

provides benefits to more than one person.


Schedule

Today we look at common property and public goods.

Then we have two lectures and a case on externalities.


Private Goods Private goods are characterized by:

Rivalry: only one person can consume the good (it is depletable).

Exclusion: others can be prevented from consuming the good.

Private goods may also involve externalities.


Common Property

Common property is defined as a resource to which everyone has free access.

Examples of common property includeFisheriesPublic grazing landsCommon pools (petroleum, water…)The internetMany roads


Public Goods Public goods are commodities or services,

such as national defense, for which consumption by one person doesn’t preclude consumption by others.

In other words, public goods lack rivalry.

The nonrivalry in a public good may have a limit; that is, the good may eventually become “congested.”


Club GoodA club good is a public good with

exclusion.Examples include a tennis club or a

concert:Security guards can keep people who don’t

have tickets from entering a concert hallThe marginal cost of adding one more

person is zero, as long as the hall is not filled (i.e. there is not congestion.)


Relationships Among Concepts A common property involves a type of

externality, namely, the impact of users on the common property.

A public good is one characterized by “non-rivalry,” in the sense that it can be provided to more than one person without raising its cost. But many public goods, like common property, are characterized by “non-excludability.”

A public good is often said to have a positive externality: because of non-rivalry, providing it to one person provides benefits to others.


Table 18.03 Rivalry and Exclusion

Note: Externalities may exist in the rivalry/exclusion celland arise by definition in the other three cells.


The Tragedy of the Commons Common property is a resource to which

everyone has free access.

Because access is free, people do not consider their impact on the resource when they use it—that is, the social cost they impose.

As a result, people over-use the common property, lowering the benefits to society.


Government Policy for Common Property

To avoid over-use, governments sometimes limit usage or place a fee on usage.

In the case of fishing, for example, some fishing areas are placed off-limits or allowable catches of certain types of fish are limited.

On highways, usage may be controlled with tolls.

We return to these policies when we analyze externalities more generally.


The Demand for Public Goods In the case of a private good, the market

demand curve is the horizontal sum of individual demand curves.

In the case of a public good, the market demand curve is the vertical sum of the individual demand curves: each additional unit goes to everyone simultaneously.

In both cases the market demand curve is the marginal social benefit curve.


The Demand for a Public GoodPrice of guard service,

$ per hour

Guards per hour

Supply, MC

25

18

13

10

87

32

5 7 940

ep es

D1

D

D2

D = Marginal Social Benefit Curve


Markets for Public GoodsPrivate markets for public goods exist only if

nonpurchasers can be excluded from consuming them.

Without the possibility of exclusion, people can be free riders, that is, they can receive the good without paying.

A market obviously cannot operate if consumers can choose not to pay!


Exclusive Public GoodsPrivate markets can exist for exclusive

(or excludable) public goods

But these markets tend to produce too little of the good because of non-rivalryMicrosoft’s marginal cost for one more unit

is virtually zeroIt’s price is much higher!


Providing Public Goods To ensure that a nonexclusive public good is

provided, the government, unlike a private firm, can levy taxes and then

Produce it Pay private firms to produce it

If the government does not provide it, all the consumer surplus associated with the good is lost.


Providing Public Goods, 2 A government often has difficulty determining the

benefits from a public good.

People may not to reveal their willingness to pay (= benefits) if they think their preferences might be linked to their taxes.

A government learns these benefits through

SurveysCitizens’ votes


Voting One simple way to think about voting is to

recognize that the outcome will always depend on the preferences of the median voter.

The median voter is defined as the voter in the middle of the distribution of voter preferences for the public good.


ExampleTraffic signal costs $300 to install.There are 3 voters, who will share the cost.Each person votes for the signal only if he or

she thinks the signal is worth at least $100 (= the tax each person will pay).

There are 3 cases (corners) in the table.In each case, Hayley is median voter, so her

views determine the outcome.



Voting and Efficiency It is efficient to provide public good if the

aggregate benefit (that is, the sum of the benefits to all households) is greater than the cost.

This is about allocative efficiency.

Majority voting may not lead to efficiency;

Voting gives each person equal weight;An efficiency calculation gives each dollar of

willingness to pay equal weight.


The Tiebout Hypothesis Local public goods and services are

characterized by congestion. A famous article by Charles Tiebout in 1956

argued that voters reveal their preferences for local public goods and services through their choice of a community.

Picking a community is like buying a shirt, he said, so if there are many communities, the outcome should be equally efficient.


The Tiebout LiteratureSubsequent analysis has revealed that

having many local governments with different levels of service is more efficient than having a single local government.

But a system with many local governments is perfectly efficient only under extreme assumptions, and policies to promote efficiency may still be needed.

And this system is unlikely to be equitable.


The Tiebout Literature, 2

For example, local communities will be perfectly homogeneous only under extreme assumptions (such as completely flexible jurisdiction boundaries).

But if communities are heterogeneous, the median voter may not pick the efficient level of local public services.

Documents

PPA 723: Managerial Economics Lecture 17: Public Goods The Maxwell School, Syracuse University Professor John Yinger