Intermediate Microeconomics Module 21 Public Goods

PUBLIC GOODS 449 CHAPTER 21 Public Goods THE POLICY QUESTION SHOULD THE GOVERNMENT REGULATE THE EXTRACTION OF FISH FROM THE OCEAN IN WATERS WITHIN TEN NAUTICAL MILES OF THE US SHORELINE ?

EXPLORING THE POLICY QUESTION . Does the societal benefit from the advent of new drugs outweigh the cost to society from the creation of monopolies ?

What other way could society promote the development of new medicines ?

LEARNING OBJECTIVES What Is a Public Good ?

Learning Objective Describe the two key features of a public good . The Problem Learning Objective Explain how public goods lead to overuse . Problems with the Public Provision of Public Goods Learning Objective Describe the problem of of public goods . Policy Example Policing Fish Extraction within 10 Nautical Miles ofthe US Shoreline Learning Objective Explain how the application of property rights can help solve the problem in fisheries . WHAT IS A PUBLIC GOOD ?

Learning Objective Describe the two key features of a public good . Public goods are goods that have some degree of and . Rival goods are goods that are diminished with use . An example ofa rival good is a sandwich . When someone consumes 449 450 PATRICK EMERSON a sandwich , that sandwich is gone , and no one else can consume it . goods are goods that do not diminish with individual consumption for example , no amount of consumption of the music from a radio station leaves any less music for anyone else with a radio to listen to . Clean air , national defense , and lighthouses are other classic examples of goods . Exclusive goods are goods for which sumption can be controlled or prevented . The sandwich behind the deli counter in a market is an good consumption can only happen if the deli workers allow it . goods are things like the roads and parks in a city anyone can drive on the roads or enjoy the park . Fisheries are another example of . Private goods are , like the sandwich , goods that are both rival and exclusive . What this textbook has been discussing all along are private goods . But what happens when the goods have some some ?

Public goods like these are subject to market failures . For example , pose someone tried to charge a price for a radio transmission . The result would be that no one would pay that price because they can get the radio signal for free , and there is no way to stop those that pay from receiving the signal . This is known as the consume a good that has a positive marginal cost . We can classify goods based on the presence of rivalry and , as is shown in table below . We divide goods into four categories . Private Goods Goods that have both rivalry and exclusion ( and are the type of goods we have studied up to this point ) Public Goods Goods that are both and . Club Goods Goods that are excludable but and . Common Resources Goods that are rival but . Table Goods based on the of rival and Excludable Private goods sandwich , gasoline , computer Common property resources fishery , roads , parks Club goods satellite radio , cable , sporting event Public goods clean air , national defense , lighthouse We also distinguish between pure public goods , goods that are completely and like radio transmissions , and impure public goods , which have at least some of both and . City roads are an example of an impure public good they are but not car takes up a little of the road space , a tiny bit less for others . 212 THE PROBLEM Learning Objective Explain how public goods lead to overuse . Public goods are both and . For example , national defense is a public good . All residents of a country enjoy the protection of military defense of the territory no one is excluded or

GOODS 451 excludable . And no matter how much one individual consumes of national defense , there isjust as much national defense of the other residents of the country , so it is . Market failures in the provision of public goods arise for a very simple reason since can not be prevented from consuming the good , the incentives to pay for the good are diminished . We call this problem the problem . It is easy to understand this when we think about individual incentives . Utility for the consumption of a public good is increased the less the consumer pays for it . We can illustrate this with a simple example of two neighbors with adjacent properties considering erecting a fence between their properties to provide privacy . Neighbor is a private person and someone who values privacy very highly . Neighbor is someone who values privacy but much less than neighbor . Figure shows the demand curves for the two neighbors of the length of the privacy fence in meters . is Neighbor demand curve , and is Neighbor demand curve . These demand curves resent the value to each neighbor of a meter of fence . By adding these two values together , we get the true social benefit ofthe fence , and we can show this in the figure as the vertical sum ofthe two demand curves , which is labeled , where stands for social benefit . For example , to erect a fence , Neighbor is willing to pay 30 a meter , and Neighbor is willing to pay 20 a meter . The social willingness to pay for the shared fence is the sum of the two individual willingness to pay , or 50 . Notice immediately that the social marginal benefit of the good is not the same as the private marginal benefits for either neighbor . Utility , 100 ) 75 ) zu ( zu ( 55 ) 50 ) 50 65 75 100 Wealth , Figure problem and the goods Contrast this with a private good , where consumption benefits only the buyer , and therefore , the social marginal benefit is the same as the private marginal benefit . Recall that when determining the total demand or the social marginal benefit curve for the market for a private good , we sum the individual demand curves horizontally because the benefit to a consumer only comes from when they consume their own private units of the good . The difference here is the lack of rivalry the same unit of a public good benefits all consumers in the market . So we have to add up all the individual benefits for each unit ofthe public good or sum the demand curves vertically .

452 PATRICK EMERSON Fences are costly , however , and we will assume that the cost per meter of erecting a fence is 50 . This is the marginal cost of fencing and is the social marginal cost , since that is the total cost to the two of erecting a meter of fence . The socially optimal amount of fencing for the two neighbors is the point at which the social marginal benefit of the fence , given by the demand curve , intersects with the marginal cost of the fence . In figure , this intersection occurs at ten meters . To understand what will actually occur , notice that the individually optimal amount of fencing for Neighbor is six meters . In other words , ifthe neighbor was going to build a fence individually , six meters is the amount that neighbor would build . Neighbor would not build any fence individually , as the cost of building is higher than the marginal benefit , even for the first meter of fence . Since Neighbor does not want to collaborate on the fence , Neighbor will build it alone and will build six meters of fence , and Neighbor will enjoy the benefit ofthe fence without contributing to it . We see in this example how the private provision of public goods is subject to Neighbor free rides off bor fence , and thus only six meters of fencing is constructed , while ten meters is socially optimal . To ensure public goods are provided , governments usually step in and provide the good themselves or subsidize or mandate its provision . An example is local fire departments . Fire protection is a classic public good all those in the fire district benefit from the service , and the protection of one household leaves no less for the other households in the district . Left to the market , we can be confident that a optimal amount of fire protection would be provided , thus it becomes part of the accepted role of the government to levy a tax on homeowners and provide fire protection themselves . PROBLEMS WITH THE PUBLIC PROVISION OF PUBLIC GOODS Learning Objective Describe the problem of of public goods . In order to value public goods , you must look beyond the market valuation . Because ofthe presence of free , the market will undervalue public goods . Alternatively , governments can rely on surveys , but these types of surveys are often poor because it is very hard to judge the value of a public good to an individual . An individual might be able to answer how much they would be willing to pay for a posed new park in their neighborhood , but how much is the police protection they enjoy worth ?

Without knowing what life would be like in the absence of a police force , that is a very difficult question to answer . Other things for which individuals lack enough information to value correctly could include clean air and drinking water , national defense , and public education . Another way to both value and potentially provide public goods is through a popular vote . This seems to be a reasonable solution on the surface , but upon examination , it is clear that the ability a tem to provide public good rests pivotally on the median voter . Consider the following example suppose a town on a river is considering building a bridge over the river . To keep the analysis simple , let assume a simplified world where there are five residents of the town , and the bridge costs exactly to construct . The bridge is worth different amounts to each resident depending on factors such as income , how close they live to the bridge , how often they pate using the bridge , and so on . Table lists each resident and their maximum willingness to pay for a bridge , which is a measure of the monetary value to them ofthe bridge .

PUBLIC GOODS 453 Table Resident to a for a new bride Resident ID price ( Resident A 500 Resident 350 Resident 175 Resident 150 Resident 125 Total Value to Society Note that the total value to the society of the new bridge is , which is more than the cost of , and so from a social welfare perspective , the bridge should be community will see a net fit from doing so . Suppose the town proposes a tax of 200 on each resident , which would net exactly the needed to build the bridge . When put to a vote , this proposal will fail because Residents , and will all vote no the 200 they are being asked to pay is greater than their individual benefit . Note that the pivotal voter in this is Resident If Resident willingness to pay were 200 or more , they would vote yes . Resident is the median voter , halfway from the top and bottom , and the construction of the bridge will rest crucially on their valuation relative to the individual cost . It is also worth noting that other means of provision in this case are also problematic . Voluntary would fall prey to the problem , as , and all know that their contributions are not needed provided the others contribute fully and will therefore withhold . A toll would have to raise the cost and thus would be the equivalent ofthe 200 tax . In this case , the voting would happen by use and would pay 200 to use it , and the toll revenues would fall far short ofthe cost ofthe bridge . If these were closely related to income , then charging a tax as a percentage of income might work , but if they have more to do with proximity , patterns , and so on , this approach would fail as well . So how do public goods get provided in most cases ?

Out of general funds from the government . By packaging together a whole host of public goods , including roads , parks , schools , libraries , public safety , and the like , governments can average out individual differences related to preferences and create broad support for the funding ofthese activities . POLICY EXAMPLE SHOULD THE GOVERNMENT REGULATE THE EXTRACTION OF FISH FROM THE OCEAN IN WATERS WITHIN TEN NAUTICAL MILES OF THE US SHORELINE ?

Learning Objective Explain how the application of property rights can help solve the problem in fisheries . When fishing boats set out on the ocean and decide how many fish to catch , like any economic actor , they make a marginal benefit , marginal cost calculation . They will continue to fish as long as their marginal benefit , the value of the next fish caught , equals the private marginal cost , the expense of catching the last fish . As a resource , however , there is a social cost to the boat catch that is not part of their calculation the fact that the more fish they catch , the fewer fish there are for others to catch . In addition , fisheries need a healthy population of mature fish to remain uncaught so that those fish can reproduce and provide fish to catch next season . In this situation , the private marginal cost and the social marginal cost differ due to the cost of ing the fishery from one fishing boat catch . Without regulation , each individual boat will catch more than the socially optimal amount , leading to deadweight loss .

454 PATRICK EMERSON With the application of property a quota system that assigns the right of an individual fishing boat to catch only a limited amount of socially optimal amount of fish extraction is established . REVIEW TOPICS AND RELATED LEARNING OUTCOMES What Is a Public Good ?

Learning Objective Describe the two key features of a public good . The Problem Learning Objective Explain how public goods lead to overuse . Problems with the Public Provision of Public Goods Learning Objective Describe the problem of of public goods . Policy Example Policing Fish Extraction within 10 Nautical Miles of the US Shoreline Learning Objective Explain how the application of property rights can help solve the problem in fisheries . LEARN KEY TOPICS Terms Public goods Public goods are goods that have some degree of and . We also distinguish between pure public goods , goods that are completely and like radio transmissions , and impure public goods that have at least some of both and . City roads are an example of an impure public good , they are but they are not perfectly , each car takes up a little of the road space leaving just a tiny bit less for others . Rival goods Rival goods are goods that are diminished with use . An example of a rival good is a sandwich , when someone consumes a sandwich that sand is gone and no one else can consume it . goods are goods that do not diminish with individual consumption , for example no amount of consumption of the music from a radio station leaves any less music for anyone else with a radio to listen to . Clean air , national defense and lighthouses are other classic examples of goods . Exclusive goods Exclusive goods are good for which consumption can be controlled or prevented . The sandwich behind the deli counter in a market is an good , consumption can only happen if the deli workers allow it . goods are things like the roads and parks in a city where one can drive on the roads or enjoy the park . Fisheries are another example of . Private goods Private goods are goods that are both rival and exclusive .