VII. Market failure

    C. Public goods

    Def. A public good is a good which is not depleted by an additional user (nondepletability or nonrivalry)
    also called non-rivalry

    like an extreme case of external benefits: many share in the consumption of the good (so demand is going to be a vertical summation again)

    Meaning: once a PG is produced the MC of permitting another user to consume it is about zero

    Ex:
    national defense
    parks
    streetlights
    highways
    lighthouse
    fire and police protection to some extent
    broadcasts
    charity
    museums
    information

    Problems: Private markets tend to:
    (1) underproduce public goods
    (2) serve too few consumers with whatever amount is produced

    "free rider": someone who consumes a good without contributing to its cost.

    Problem (1): underproduction is due to the "free rider" problem
    Why? It is frequently very expensive to exclude non-payers from using a public good, so there is a strong consumer tendency to "let the other person pay for it" (non-excludability)
    Since private markets rely on voluntary transactions, they can't coerce beneficiaries to pay, so we get a free rider problem

    A pure public good: a public good which free riders cannot be excluded from using (non-excludability)
    Ex: lights on oxy campus

    In practice, there is an incentive to be an illegitimate free rider.

    Ex: defense consider incentive to free ride:
    defense budget:
    defense share for a family of 4:
    defense if a family doesn't pay:

    It is the free rider problem, born of non-excludability which leads to the public sector provision of public goods.

    Problem (2): too few are served since, with MC=0 for serving others, everyone should be allowed to consume a public good once it is produced
    --anyone who attaches any value to the good should be allowed to have it
    --private firms do not give output away
    --i.e., some legitimate free riders get excluded
    Ex's: software piracy; cable signal piracy

    1. Private goods versus public goods

    Output efficiency occurs where SMB = SMC

    For any individual, MB of any unit consumed = vertical distance to the indivdual's. D.

    Contrast with private good
    Private good: only one person consumes each unit produced. I drink a beer--no one else can.
    So, each unit demanded imposes a separate marginal cost on society and generates benefit for only one consumer

    Public good: all individuals consume the entire output produced. I put the beer in a museum--all can enjoy looking at it so, each time costs are incurred in producing output, benefits are generated for many consumers.
    Each unit produced can generate benefits from many consumers.

    As with externalities, the key is sharing. In fact, many economists consider PGs as the ultimate example of externality.

    2. Economic analysis of public goods

    Do public goods worksheet

    Note: ideal prices = Lindahl prices = Individual Ps = individual MBs for a public good (imposed as taxes)

    approximate Lindahl pricing in practice:
    --gas tax for highways
    --cigarette tax for lung cancer research
    --income tax for defense

Next topic