Principles of Microeconomics Scarcity and Social Provisioning Chapter 19 Positive Externalities and Public Goods

CHAPTER 19 . POSITIVE AND PUBLIC GOODS INTRODUCTION TO POSITIVE AND PUBLIC GOODS Figure . View from Voyager . Launched by NASA on September , 1977 , Voyager primary mission was to provide detailed images , Saturn , and their moons . It took this photograph on its journey . In August of 2012 , Voyager I entered interstellar first object to do it is expected to send data and images back to earth until 2025 . Such a technological feat has a lot to do with economic principles . Credit modification of work by ) THE BENEFITS OF VOYAGER I LIVE ON The rapid growth of technology has increased our ability to access and process data , to navigate through a busy city , and to communicate with friends on the other side of the globe . The research and development efforts of citizens , scientists , firms , universities , and governments have truly revolutionized the modern economy . To get a sense of how far we have come in a short period of time , let compare one of humankind greatest achievements to the smartphone most of us have in our coat pocket . In 1977 the United States launched Voyager I , a spacecraft originally intended to reach Jupiter and Saturn , to send back

PRINCIPLES or ECONOMICS 521 photographs and other cosmic measurements . Voyager I , however , kept going , and Jupiter and out of our solar system . At the time of its launch , Voyager had some of the most sophisticated computing processing power NASA could engineer ( instructions per second ) but by the time it left the solar system ( in 2012 , actually ) we were using handheld devices that could process 14 billion instructions per second . Still , the technology of today is a spillover product of the incredible feats accomplished by NASA thirty years ago . NASA research , for instance , is responsible for the kidney dialysis and mammogram machines that we use today . Research in new technologies not only produces private benefits to the investing firm , or in this case to NASA , but it also creates benefits for the broader society . In this way , new knowledge often becomes what economists refer to as a public good . This leads us to the topic of this , positive , public goods , and the role of government in the ment of innovation and the social benefits that it provides . OB ( Introduction to Positive and Public Goods In this chapter , you will learn about Why the Private Sector Under Invests in Technologies How Governments Can Encourage Innovation Public Goods an you imagine a world in which you did not own a cellular phone or use Wikipedia ?

New technology changes how people live and work and what they buy . Technology includes the invention of new products , new ways of producing goods and services , and even new ways of managing a company more efficiently . Research and development of technology is the difference between horses and automobiles , between candles and electric lights , between fetching water in ets and indoor plumbing , and between infection and good health from antibiotics . In December 2009 , ABC News compiled a list of some of the technological breakthroughs that have revolutionized consumer products in the past 10 years tracking devices , originally developed by the defense department and available to consumers in 2000 , give users information on location and time through satellite technology . In 2000 , introduced the Prius hybrid car , which greatly improved fuel efficiency . Also in 2000 , AT offered its customers the ability to text on a mobile phone . In 2001 , Wikipedia launched a encyclopedia on the Web . Even though Napster died in 2001 , the company launched music downloading and file sharing , which revolutionized how consumers get their music and videos . kicked off the social networking business in 2003 , and Twitter and Facebook followed . In 2003 , the Human Genome project was completed . It helps to fight disease and launch new pharmaceutical innovations .

522 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER Also in 2003 , the search engine became a way of life for obtaining information quickly . The search engine companies also became innovators in the digital software that dominates mobile devices . In 2006 , Nintendo launched and changed the way video games are played . Players can now be drawn into the action and use their bodies to respond rather than a handheld device . Apple introduced the iPhone in 2007 and launched an entire smartphone industry . In 2015 , cell phones now recognize human voices via artificial intelligence . With all new technologies , however , there are new challenges . This chapter deals with some of these issues Will private companies be willing to invest in new technology ?

In what ways does new have positive ?

What motivates inventors ?

Does government have a role to play in encouraging research and technology ?

Are there certain types of goods that markets fail to vide efficiently , and that only government can produce ?

What happens when consumption or duction of a product creates positive ?

Why is it unsurprising when a common resource , like marine fisheries , is overused ?

WHY THE PRIVATE SECTOR UNDER INVESTS IN INNOVATION LEARNING By the end of this section , you will be able to Identify the positive of new technology . Explain the difference between private benefits and social benefits and give examples of each . Calculate and analyze rates of return competition can provide an incentive for discovering new technology because a firm can earn higher profits by finding a way to produce products more cheaply or to create products with characteristics consumers want . As Gregory Lee , CEO of said , Relentless pursuit of new innovation is the key principle of our business and enables consumers to discover a world of possibilities with An innovative firm knows that it will usually have a temporary edge over its competitors and thus an ability to earn profits before can catch up . In certain cases , however , competition can discourage new technology , especially when other firms can quickly copy a new idea . Consider a pharmaceutical firm deciding to develop a new drug . On average , it can cost 800 million and take more than a decade to discover a new drug , perform the necessary safety tests , and bring the drug to market . If the research and development ( effort every project has some chance of the firm will suffer losses and could even be driven out of business . If the project succeeds , then the firms competitors may figure out ways of adapting and copying the underlying idea , but without having to pay the costs themselves . As a result , the innovative company will bear the much higher costs of the and will enjoy at best only a small , temporary advantage over the competition . Many inventors over the years have discovered that their inventions brought them less profit than they might have reasonably expected . Eli Whitney ( invented the cotton gin , but then southern cotton planters built their own devices with a few minor changes in Whitney design . When Whitney sued , he found that the courts in southern states would not uphold his patent rights . Thomas Edison ( still holds the record for most patents granted to an individual .

524 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER His first invention was an automatic vote counter , and despite the social benefits , he could not find a government that wanted to buy it . Gordon Gould came up with the idea behind the laser in 1957 . He put off applying for a patent and , by the time he did apply , other scientists had laser inventions of their own . A lengthy legal battle resulted , in which Gould spent on lawyers , before he eventually received a patent for the laser in 1977 . Compared to the enormous social benefits of the laser , Gould received relatively little financial reward . In 1936 , Turing delivered a paper titled , On Computable Numbers , with an Application to the , in which he presented the notion of a universal machine ( later called the Universal Turing Machine , and then the Turing machine ) capable of computing anything that is computable . The central concept of the modern computer was based on Turing paper . A variety of studies by economists have found that the original inventor receives to half of the total economic benefits from innovations , while other businesses and new product users receive the rest . THE POSITIVE OF NEW TECHNOLOGY Will private firms in a market economy under invest in research and technology ?

If a firm builds a factory or buys a piece of equipment , the firm receives all the economic benefits that result from the investments . However , when a firm invests in new technology , the private benefits , or profits , that the firm receives are only a portion of the overall social benefits . The social benefits of an tion take into account the value of all the positive of the new idea or product , whether enjoyed by other companies or society as a whole , as well as the private benefits received by the firm that developed the new technology . As you learned in Environmental Protection and Negative , positive are beneficial to a third party , or parties . Consider the example of the Big Drug Company , which is planning its budget for the next year . Economists and scientists working for Big Drug have compiled a list of potential research and projects and estimated rates of return . The rate of return is the estimated payoff from the project . Figure shows how the calculations work . The , curve represents the firms demand for financial capital and the willingness to borrow to finance research and development projects at various interest rates . Suppose that this firm investment in research and development creates a spillover benefit to other firms and households . After all , new innovations often spark other creative endeavors that society also values . If we add the spillover society enjoys to the firms private demand for financial capital , we can draw that lies above If there was a way for the firm to fully monopolize those social benefits by somehow making them unavailable to the rest of us , the firms private demand curve would be the same as society demand curve . According to Figure and Table , if the going rate of interest on borrowing is , and the company can receive the private benefits of innovation only , then the company would finance 30 million . Society , at the same rate of , would find it optimal to have 52 million of borrowing . Unless there is a way for the company to fully enjoy the total benefits , then it will borrow less than the socially optimal level of 52 million .

PRINCIPLES OF ECONOMICS 525 10 . I I ' 15 30 455352 60 75 3590 Quantity of Financial Capital Figure . Positive and Technology . Big Drug faces a cost of borrowing of . If the firm receives only the private benefits of investing in , then its demand curve for financial capital is shown by , and the equilibrium will occur at 30 million . Because there are spillover benefits , society would find it optimal to have 52 million of investment . If the firm could keep the social benefits of its investment for itself , its demand curve for financial capital would be and it would be willing to borrow 52 million . Rate of Return ( in millions ) in millions ) 72 84 52 72 38 62 30 52 10 26 44 Table . Return and Demand for Capital Big Drug original demand for financial capital ( is based on the profits received by the firm . However , other pharmaceutical firms and health care companies may learn new lessons about how to treat certain medical conditions and are then able to create their own competing products . The social benefit of the drug takes into account the value of all the positive of the drug . If Big Drug were able to gain this social return instead of other companies , its demand for financial capital would shift to the demand curve , and it would be willing to borrow and invest 52 million . However , if Big Drug is receiving only 50 cents of each dollar of social benefits , the firm will not spend as much on creating new products . The amount it would be willing to spend would fall somewhere in between and WHY INVEST IN HUMAN CAPITAL ?

The investment in anything , whether it is the construction of a new power plant or research in a new 526 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER cancer treatment , usually requires a certain upfront cost with an uncertain future benefit . The ment in education , or human capital , is no different . Over the span of many years , a student and her family invest significant amounts of time and money into that students education . The idea is that higher levels of educational attainment will eventually serve to increase the students future and subsequent ability to earn . Once the numbers are crunched , does this investment pay off for the student ?

Almost universally , economists have found that the answer to this question is a clear For ple , several studies of the return to education in the United States estimate that the rate of return to a college education is approximately 10 . Data in Table , from the Bureau of Labor Statistics Usual Weekly Earnings of Wage and Salary Workers , Third Quarter 2014 , demonstrate that median weekly earnings are higher for workers who have completed more education . While these rates of return will beat equivalent investments in Treasury bonds or savings accounts , the estimated returns to tion go primarily to the individual worker , so these returns are private rates of return to education . Less than a High School High School Degree , No Degree College Degree Median Weekly Earnings ( workers over the age of 25 ) 488 668 Table . Usual Weekly Earnings of Wage and Salary Workers , Third Quarter 2014 . Source ) What does society gain from investing in the education of another student ?

After all , if the ment is spending taxpayer dollars to subsidize public education , society should expect some kind of return on that spending . Again , economists like George have found that , across a variety of nations , the social rate of return on schooling is also positive . After all , positive exist from investment in education . While not always easy to measure , according to Walter , the positive to education typically include better health outcomes for the population , lower levels of crime , a cleaner environment and a more stable , democratic government . For these reasons , many nations have chosen to use taxpayer dollars to subsidize primary , secondary , and higher education . Education clearly benefits the person who receives it , but a society where most people have a good level of education provides positive for all . OTHER EXAMPLES OF POSITIVE Although technology may be the most prominent example of a positive externality , it is not the only one . For example , being vaccinated against disease is not only a protection for the individual , but it has the positive spillover of protecting others who may become infected . When a number of homes in a neighborhood are modernized , updated , and restored , not only does it increase the value of those homes , but the value of other properties in the neighborhood may increase as well . The appropriate public policy response to a positive externality , like a new technology , is to help the party creating the positive externality receive a greater share of the social benefits . In the case of , like flu shots , an effective policy might be to provide a subsidy to those who choose to get . Figure shows the market for flu shots . The market demand curve for flu shots reflects only the marginal private benefits ( that the vaccinated individuals receive from the shots . Assuming

PRINCIPLES OF ECONOMICS 527 that there are no spillover costs in the production of shots , the market supply curve is given by the marginal private cost ( of producing the vaccinations . The equilibrium quantity of shots produced in the market , where is equal to , is and the price of shots is . However , spillover benefits exist in this market because others , those who chose not to purchase a shot , receive a positive externality in a reduced chance of the . When we add the spillover benefits to the marginal private benefit of shots , the marginal social benefit ( of shots is given by . Because the is greater than , we see that the socially optimal level of shots is greater than the market quantity ( exceeds , and the corresponding price of shots , if the market were to produce , would be at . Unfortunately , the marketplace does not recognize the positive externality and shots will go under produced and under consumed . So how can government try to move the market level of output closer to the socially desirable level of output ?

One policy would be to provide a subsidy , like a voucher , to any citizen who wishes to get vaccinated . This voucher would act as income that could be used to purchase only a shot and , if the voucher was exactly equal to the spillover benefits , would increase market equilibrium to a quantity of and a price of where equals . Suppliers of the shots would receive payment of per vaccination , while consumers of shots would redeem the voucher and only pay a price of . When the government uses a subsidy in this way , the socially optimal quantity of vaccinations is produced . KEY CONCEPTS AND SUMMARY Competition creates pressure to innovate . However , if new inventions can be easily copied , then the original inventor loses the incentive to invest further in research and development . New technology often has positive that is , there are often from the invention of new technology that benefit firms other than the innovator . The social benefit of an invention , once these are taken into account , typically exceeds the private benefit to the inventor . If inventors could receive a greater share of the broader social benefits for their work , they would have a greater incentive to seek out new inventions . SELF CHECK QUESTIONS . Are positive in market demand curves ?

Why or why not ?

investment in digital devices has increased profits by 20 . Is this a private or social benefit ?

The Gizmo Company is planning to develop new household gadgets . Table shows the company demand for financial capital for research and development of these gadgets , based on expected rates of return from sales . Now , say that every investment would have an additional social is , an investment that pays at least a return to the Gizmo Company will pay at least an 11 return for society as a whole an investment that pays at least for the Gizmo Company will pay at least 12 for society as a whole , and so on . Answer the questions that follow based on this information .

523 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER ( a ' an . I ' 5033 Quantity of Flu Vaccines Figure . The Market for Flu Shots with Spillover Benefits ( A Positive Externality ) The market demand curve does not the positive externality of vaccinations , so only will be exchanged . This outcome is inefficient because the marginal social benefit exceeds the marginal social cost . If the government provides a subsidy to consumers of flu shots , equal to the marginal social benefit minus the marginal private benefit , the level of vaccinations can increase to the socially optimal quantity of . Estimated Rate of Return Private of the firm from an project ( in millions ) 10 100 102 108 118 133 153 183 223 Table a . If the going interest rate is , how much will Gizmo invest in if it receives only the private benefits of this investment ?

Assume that the interest rate is still . How much will the firm invest if it also receives the social benefits of its investment ?

Add an additional return on all levels of investment . Company travels from home to home , looking for opportunities to buy items that would PRINCIPLES OF ECONOMICS 529 otherwise be put out with the garbage , but which the company can resell or recycle . Which will be larger , the private or the social benefits ?

REVIEW QUESTIONS . In what ways do company investments in research and development create positive ?

Will the demand for borrowing and investing in be higher or lower if there are no external benefits ?

CRITICAL THINKING QUESTIONS Can a company be guaranteed all of the social benefits of a new invention ?

Why or why not ?

PROBLEMS Airlines wants to build new airplanes with greatly increased cabin space . This will allow Airlines to give passengers more comfort and sell more tickets at a higher price . However , redesigning the cabin means ing many other elements of the airplane as well , like the placement of engines and luggage , and the most efficient shape of the plane for moving through the air Airlines has developed a list of possible methods to increase cabin space , along with estimates of how these approaches would affect costs of operating the plane and sales of airline ets . Based on these estimates , Table shows the value of projects that provide at least a certain private rate of return . Column Private Rate of Return . Column Value of Projects that Return at Least the Private Rate of Return to Airlines . Use the data to answer the following questions . Private Rate of Return Value of 12 100 10 200 300 400 500 If the opportunity cost of financial capital for Airlines is , how much should the firm invest in ?

Assume that the social rate of return for is an additional on top of the private return that is , an investment that had a private return to Airlines would have a social return . How much investment is socially optimal at the interest rate ?

530 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER REFERENCES Arias , Omar and Walter . Dynamic Rates of Return to Education in the Economics of Education Review . 20 , 2001 . 2015 . Alan Accessed April , Canty Media . 2015 . The World Life Expectancy ( 2015 ) Top Accessed April , Thomas , and Robert Thornton . Fundamentals of Labor Economics . Boston Company , 2005 . Walter . Education and Development Measuring the Social Benefits . Oxford Oxford University Press , 2000 . National Institute of Health . 2015 . Global Importance of . Leadership in Science and Innovation for the Future of Our Economy and Our Accessed April , National Science Foundation . 2013 . Spending Resumes Growth in 2010 and 2011 but Still Lags Behind the Pace of Expansion of the National Accessed April , George . Returns to Investment in Education A Global World Development 22 , 1994 . Corrie . Shift to Innovative Devices Pay Inquirer Technology . Accessed May 15 , positive beneficial to a third party or parties private benefits the dollar value of all benefits of a new product or process invented by a company that can be captured by the investing company private rates of return when the estimated rates of return go primarily to an individual for example , earning interest on a savings account social benefits the dollar value of all benefits of a new product or process invented by a company that can be captured by other firms and by society as a whole social rate of return when the estimated rates of return go primarily to society for example , providing free education SOLUTIONS Answers to Questions

PRINCIPLES or ECONOMICS 531 No . A market demand curve reflects only the private benefits of those who are consuming the product . Positive are benefits that spill over to third parties , so they create social benefits , and are not captured by a market ( or private benefit ) demand curve . Clearly is benefiting from the investment , so the 20 increase in profits is a private benefit . If is unable to capture all of the benefit , perhaps because other companies quickly copy and produce close substitutes , then investment will produce social benefits . a . 102 million . If the interest rate is , the cost of financial capital , and the firm can capture the return to society , the firm Would invest as if its effective rate of return is , so it will invest 183 million . When the Company purchases something for resale , presumably both the buyer and the seller , they would not need to make the transaction . However , the company also reduces the amount of garbage produced , which saves money for households for the city that disposes of garbage . So the social benefits are larger than the private benefits .

HOW GOVERNMENTS CAN ENCOURAGE INNOVATION LEARNING By the end of this section , you will be able to Explain the effects of intellectual property rights on social and private rates of return . Identify three US . Government policies and explain how they encourage innovation number of different government policies can increase the incentives to innovate , including guaranteeing intellectual property rights , government assistance with the costs of research and development , and cooperative research ventures between universities and companies . INTELLECTUAL PROPERTY RIGHTS One way to increase new technology is to guarantee the innovator an exclusive right to that new product or process . Intellectual property rights include patents , which give the inventor the legal right to make , use , or sell the invention for a limited time , and copyright laws , which give the author an exclusive legal right over works of literature , music , and pictures . For example , if a pharmaceutical firm has a patent on a new drug , then no other firm can manufacture or sell that drug for years , unless the firm with the patent grants permission . Without a patent , the pharmaceutical firm would have to face competition for any successful products , and could earn no more than a normal rate of profit . With a patent , a firm is able to earn monopoly profits on its product for a period of offers an incentive for research and development . In general , how long can a period of time be ?

The Clear it Up discusses patent and copyright protection for some works you might have heard of . HOW LONG IS MICKEY MOUSE PROTECTED FROM BEING COPIED ?

All patents and copyrights are scheduled to end someday . In 2003 , copyright protection for Mickey Mouse was scheduled to run out . Once the copyright had expired , anyone would be able to copy Mickey Mouse cartoons or draw and sell new ones . In 1998 , however , Congress passed the Sonny Bono Copyright Term Extension Act . For copyrights owned by or other entities , it increased or extended the copyright from 75 years to 95 years after publication . For copyrights owned by individuals , it increased or extended the copyright coverage from 50 years to 70 years after death . Along with protecting Mickey for another 20 years , the copyright extension affected about books , movies , and songs . Figure illustrates how the total number of patent applications filed with the Patent and

PRINCIPLES OF ECONOMICS 533 mark Office , as well as the total number of patents granted , surged in the with the tion of the Internet , and is still going strong today . I Patents I Patents granted 400000 ' Year Figure . Patents Filed and Granted , The number of applications filed for patents increased substantially from the into the first years of the 20005 , due in part to the invention of the Internet , which has led to many other inventions and to the 1998 Copyright Term Extension Act . Source ) While patents provide an incentive to innovate by protecting the innovator , they are not perfect . For example In countries that already have patents , economic studies show that inventors receive only to of the total economic value of their inventions . In a industry like biotechnology or semiconductor design , patents may be almost irrelevant because technology is advancing so quickly . Not every new idea can be protected with a patent or a example , a new way of organizing a factory or a new way of training employees . Patents may sometimes cover too much or be granted too easily . In the early , Xerox had received over patents on Various elements of the photocopy machine . Every time Xerox improved the photocopier , it received a patent on the improvement . The time period for a patent is somewhat arbitrary . Ideally , a patent should cover a long enough period of time for the inventor to earn a good return , but not so long that it allows the inventor to charge a monopoly price permanently . Because patents are imperfect and do not apply well to all situations , alternative methods of ing the rate of return for inventors of new technology are desirable . Some of these possible alternative policies are described in the following sections .

534 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER POLICY GOVERNMENT SPENDING ON RESEARCH AND DEVELOPMENT If the private sector does not have sufficient incentive to carry out research and development , one possibility is for the government to fund such work directly . Government spending can provide direct financial support for research and development ( done at colleges and universities , nonprofit research entities , and sometimes by private firms , as well as at laboratories . While government spending on research and development produces technology that is broadly available for firms to use , it costs taxpayers money and can sometimes be directed more for political than for or economic reasons . Visit the NASA website and the website to read about government research that would not take place where it left to firms due to the . The first column of Table shows the sources of total spending on research and development the second column shows the total dollars of funding by each source . The third column shows that , relative to the total amount of funding , 26 comes from the federal government , about 67 of is done by industry , and less than is done by universities and colleges . The percentages below do not add up to exactly 100 due to rounding . Sources of Funding Amount ( billions ) Percent of the Total Federal government 32 Industry 249 Universities and colleges 125 Nonfederal government Total 5414 Table . US . Research and Development Expenditures , 201 . Source ) In the the federal government paid for about of the nations . Over time , the economy has come to rely much more heavily on . The federal ment has tried to focus its direct spending on areas where private firms are not as active . One difficulty with direct government support of is that it inevitably involves political decisions about which projects are worthy . The scientific question of whether research is worthwhile can easily become entangled with considerations like the location of the congressional district in which the research funding is being spent .

PRINCIPLES or ECONOMICS 535 POLICY TAX BREAKS FOR RESEARCH AND DEVELOPMENT A complementary approach to supporting that does not involve the governments close scrutiny of specific projects is to give firms a reduction in taxes depending on how much research and they do . The federal government refers to this policy as the research and experimentation ( tax credit . According to the Treasury Department . the Credit is also a policy for stimulating additional private sector investment . Most recent studies find that each dollar of foregone tax revenue through the Tax Credit causes firms to invest at least a dollar in , with some studies finding a benefit to cost ratio of or Visit this website for more information on how the Tax Credit encourages investment . El El ' I ha POLICY COOPERATIVE RESEARCH State and federal governments support research in a variety of ways . For example , United for Medical Research , a coalition of groups that seek funding for the National Institutes of Health , which is supported by federal grants ) states research added 69 billion to our and supported seven million jobs in 2011 The United States remains the leading sponsor of research spending 17 billion in 201 . Other institutions , such as the National Academy of Scientists and the National Academy of Engineers , receive federal grants for innovative projects . The Agriculture and Food Research Initiative ( at the United States Department of ture awards federal grants to projects that apply the best science to the most important agricultural problems , from food safety to childhood obesity . Cooperation between ties , academies , and the private sector can spur product innovation and create whole new industries . KEY CONCEPTS AND SUMMARY Public policy with regard to technology must often strike a balance . For example , patents provide an incentive for inventors , but they should be limited to genuinely new inventions and not extend ever . Government has a variety of policy tools for increasing the rate of return for new technology and encouraging its development , including direct government funding of , tax incentives for , protection of intellectual property , and forming cooperative relationships between universities and the private sector .

536 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER SELF ' QUESTIONS . When a neighborhood is cleaned up and kept neat , there are a number of positive higher property values , less crime , happier residents . What types of government policies can encourage neighborhoods to clean up ?

Education provides both private benefits to those who receive it and broader social benefits for the economy as a Whole . Think about the types of policies a government can follow to address the issue of positive in technology and then suggest a parallel set of policies that governments could follow for addressing positive in education . REVIEW QUESTIONS . Why might private markets tend to provide too few incentives for the development of new technology ?

What can government do to encourage the development of new technology ?

CRITICAL THINKING QUESTIONS Is it inevitable that government must become involved in supporting investments in new technology ?

PROBLEMS The marginal private costs and the marginal private benefits of a firm producing cars is represented in the following diagram ( show the equilibrium , The government would like to increase the amount of cars to be produced and sold to . One Way that the government can try to increase production of cars is by making them cheaper to produce , by subsidizing their production . Show , on the same graph , the amount of subsidy needed to increase the equilibrium quantity of cars to . Him the government is trying to affect production through costs , not benefits . REFERENCES United States Department of the Treasury . Research and Experimentation Tax Accessed November . Patent and Trademark Office . 2015 . US . Patent Statistics Calendar Years Accessed April 10 , United for Medical Research . Profiles of Prosperity How Research Is Fueling Sector Growth and Introduction . Accessed January .

PRINCIPLES OF ECONOMICS 537 intellectual property the body of law including patents , trademarks , copyrights , and trade secret law that protect the right of inventors to produce and sell their inventions SOLUTIONS Answers to Questions . Government programs that either pay for neighborhood directly or that provide reduced tax payments for those who clean up or fix up their own property could be enacted . It is also easy to imagine how a city might allow its businesses to form a group that would pay for and manage neighborhood cleanup . Government programs that either pay for education directly or that provide loans or reduced tax payments for education could create positive . A city might allow its businesses to form a group that would coordinate business efforts with schools and local colleges and students to obtain experience in their chosen fields and providing businesses with enthusiastic , trained Workers .

PUBLIC GOODS LEARNING OBJECTIVES By the end of this section , you will be able to Identify a public good using and as criteria Explain the free rider problem Identify several sources of public goods ven though new technology creates positive so that perhaps or of the social benefit of new inventions spills over to others , the inventor still receives some return . What about a situation where the positive are so extensive that private firms could not expect to receive any of the social benefit ?

This kind of good is called a public good . Spending on national defense is a good example of a public good . Let begin by defining the of a public good and discussing why these characteristics make it difficult for private firms to supply public goods . Then we will see how government may step in to address the issue . THE DEFINITION OF A PUBLIC GOOD Economists have a strict definition of a public good , and it does not necessarily include all goods financed through taxes . To understand the defining characteristics of a public good , first consider an ordinary private good , like a piece of pizza . A piece of pizza can be bought and sold fairly easily because it is a separate and identifiable item . However , public goods are not separate and identifiable in this way . Instead , public goods have two defining characteristics they are and . The first characteristic , that a public good is , means that it is costly or impossible to exclude someone from using the good . If Larry buys a private good like a piece of pizza , then he can exclude others , like Lorna , from eating that pizza . However , if national defense is being provided , then it includes everyone . Even if you strongly disagree with America defense policies or with the level of defense spending , the national defense still protects you . You can not choose to be unprotected , and national defense can not protect everyone else and exclude you . The second main characteristic of a public good , that it is , means that when one person uses the public good , another can also use it . With a private good like pizza , if Max is eating the pizza then Michelle can not also eat it that is , the two people are rivals in consumption . With a public good

PRINCIPLES or ECONOMICS 539 like national defense , Max consumption of national defense does not reduce the amount left for Michelle , so they are in this area . A number of government services are examples of public goods . For instance , it would not be easy to provide fire and police service so that some people in a neighborhood would be protected from the burning and burglary of their property , while others would not be protected at all . Protecting some necessarily means protecting others , too . Positive and public goods are closely related concepts . Public goods have positive , like police protection or public health funding . Not all goods and services with positive , however , are public goods . Investments in education have huge positive but can be provided by a private company . Private companies can invest in new inventions such as the Apple iPad and reap profits that may not capture all of the social benefits . Patents can also be described as an attempt to make new inventions into private goods , which are excludable and rivalrous , so that no one but the inventor is allowed to use them during the length of the patent . THE FREE RIDER PROBLEM OF PUBLIC GOODS Private companies find it difficult to produce public goods . If a good or service is , like national defense , so that it is impossible or very costly to exclude people from using this good or vice , then how can a firm charge people for it ?

Visit this Website to read about a connection between free riders and bad music . When individuals make decisions about buying a public good , a free rider problem can arise , in which people have an incentive to let others pay for the public good and then to free ride on the purchases of others . The free rider problem can be expressed in terms of the prisoners dilemma game , which is discussed as a representation of oligopoly in Monopolistic Competition and Oligopoly . Say that two people are thinking about contributing to a public good Rachel and Samuel . When either of them contributes to a public good , such as a local fire department , their personal cost of doing so is and the social benefit of that persons contribution is . Because society benefit of is greater than the cost of , the investment is a good idea for society as a whole . The problem is that , while Rachel and Samuel pay for the entire cost of their contribution to the public good , they receive only half of the benefit , because the benefit of the public good is divided equally among the members of society . This sets up the prisoners dilemma illustrated in Table .

540 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER Samuel ( Contribute Samuel ( Do Not Contribute pays , receives , net gain pays , receives , net gain Rachel ( Contribute pays , receives , net gain pays , receives , net gain pays , receives , net gain pays , receives Rachel ( Do Not Contribute pays , receives , net gain pays , receives Table . Contributing to a Public Good as a Prisoner Dilemma If neither Rachel nor Samuel contributes to the public good , then there are no costs and no benefits of the public good . Suppose , however , that only Rachel contributes , while Samuel does not . Rachel incurs a cost of , but receives only of benefit ( half of the total of benefit to society ) while Samuel incurs no cost , and yet he also receives of benefit . In this outcome , Rachel actually loses while Samuel gains . A similar outcome , albeit with roles reversed , would occur if Samuel had , but Rachel had not . Finally , if both parties contribute , then each incurs a cost of and each receives of benefit ( half of the total 12 benefit to society ) There is a dilemma with the Prisoner Dilemma , though . See the Work it Out feature . THE PROBLEM WITH THE PRISONER DILEMMA The difficulty with the prisoner dilemma arises as each person thinks through his or her strategic choices . Step . Rachel reasons in this Way If Samuel does not contribute , then I would be a fool to contribute . However , if Samuel does contribute , then I can come out ahead by not contributing . Step . Either Way , I should choose not to contribute , and instead hope that I can be a free rider who uses the public good paid for by Samuel . Step . Samuel reasons the same Way about Rachel . Step . When both people reason in that way , the public good never gets built , and there is no movement to the option Where everyone is actually best for all parties . THE ROLE OF GOVERNMENT IN PAYING FOR PUBLIC GOODS The key insight in paying for public goods is to find a way of assuring that everyone will make a contribution and to prevent free riders . For example , if people come together through the political process and agree to pay taxes and make group decisions about the quantity of public goods , they can defeat the free rider problem by requiring , through the law , that everyone contributes . However , government spending and taxes are not the only way to provide public goods . In some cases , markets can produce public goods . For example , think about radio . It is , since once the radio signal is being broadcast , it would be very difficult to stop someone from receiving it . It is , since one person listening to the signal does not prevent others from listening as well . Because of these features , it is practically impossible to charge listeners directly for listening to radio broadcasts . Radio has found a way to collect revenue by selling advertising , which is an indirect way of charging listeners by taking up some of their time . Ultimately , consumers who purchase the goods advertised are also paying for the radio service , since the cost of advertising is built into the product cost . In a more recent development , satellite radio companies , such as , charge a regular subscription

PRINCIPLES or ECONOMICS 541 fee for streaming music without commercials . In this case , however , the product is those who pay for the subscription will receive the broadcast . Some public goods will also have a mixture of public provision at no charge along with fees for some purposes , like a public city park that is free to use , but the government charges a fee for parking your car , for reserving certain picnic grounds , and for food sold at a refreshment stand . Read this article to find out what economists say the government should pay for . El . El In other cases , social pressures and personal appeals can be used , rather than the force of law , to reduce the number of free riders and to collect resources for the public good . For example , neighbors sometimes form an association to carry out beautification projects or to patrol their area after dark to discourage crime . In countries , where social pressure strongly encourages all farmers to participate , farmers in a region may come together to work on a large irrigation project that will all . Many fundraising efforts , including raising money for local charities and for the endowments of colleges and universities , also can be viewed as an attempt to use social pressure to discourage free riding and to generate the outcome that will produce a public benefit . COMMON RESOURCES AND THE TRAGEDY OF THE COMMONS There are some goods that do not fall neatly into the categories of private good or public good . While it is easy to classify a pizza as a private good and a city park as a public good , what about an item that is and rivalrous , such as the queen conch ?

In the Caribbean , the queen conch is a large marine mollusk found in shallow waters of sea grass . These waters are so shallow , and so clear , that a single diver may harvest many conch in a single day . Not only is conch meat a local delicacy and an important part of the local diet , but the large ornate shells are used in art and can be crafted into musical instruments . Because almost anyone with a small boat , snorkel , and mask , can participate in the conch harvest , it is essentially . At the same time , fishing for conch is rivalrous once a diver catches one conch it can not be caught by another diver . Goods that are and rivalrous are called common resources . Because the waters of the Caribbean are open to all conch fishermen , and because any conch that you catch is conch that I not catch , common resources like the conch tend to be . The problem of common resources is not a new one , but ecologist Garret put the tag Tragedy of the Commons to the problem in a 1968 article in the magazine Science .

542 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER mists view this as a problem of property rights . Since nobody owns the ocean , or the conch that crawl on the sand beneath it , no one individual has an incentive to protect that resource and responsibly harvest it . To address the issue of conch and other marine fisheries , economists advocate simple devices like fishing licenses , harvest limits , and shorter fishing seasons . When the population of a species drops to critically low numbers , governments have even banned the vest until biologists determine that the population has returned to sustainable levels . In fact , such is the case with the conch , the harvesting of which has been effectively banned in the United States since 1986 . Visit this Website for more on the queen conch industry . POSITIVE IN PUBLIC HEALTH PROGRAMS One of the most remarkable changes in the standard of living in the last several centuries is that ple are living longer . Thousands of years ago , human life expectancy is believed to have been in the range of 20 to 30 years . By 1900 , average life expectancy in the United States was 47 years . By 2015 , life expectancy is 79 years . Most of the gains in life expectancy in the history of the human race in the twentieth century . The rise in life expectancy seems to stem from three primary factors . First , systems for providing clean water and disposing of human waste helped to prevent the transmission of many diseases . ond , changes in public behavior have advanced health . Early in the twentieth century , for example , people learned the importance of boiling bottles before using them for food storage and baby milk , washing their hands , and protecting food from . More recent behavioral changes include ing the number of people who smoke tobacco and precautions to limit sexually transmitted diseases . Third , medicine has played a large role . for diphtheria , cholera , pertussis , tuberculosis , tetanus , and yellow fever were developed between 1890 and 1930 . Penicillin , discovered in 1941 , led to a series of other antibiotic drugs for bringing infectious diseases under control . In recent decades , drugs that reduce the risks of high blood pressure have had a dramatic effect in extending lives . These advances in public health have all been closely linked to positive and public goods . Public health officials taught hygienic practices to mothers in the early and encouraged less smoking in the late . Many public sanitation systems and storm sewers were funded by because they have the key traits of public goods . In the twentieth century , many medical discoveries came out of government or research . Patents and intellectual property rights provided an additional incentive for private inventors . The reason for requiring , phrased in economic terms , is that it prevents of illness to well as helping the person immunized .

PRINCIPLES OF ECONOMICS 543 THE BENEFITS OF VOYAGER I LIVE ON While We applaud the technology of NASA space projects , We should also acknowledge that those benefits are not shared equally . Economists like Tyler , a professor at George Mason University , are seeing more and more of a Widening gap between those who have access to rapidly improving technology , and those who do not . According to author of the recent book , Average Is Over Powering America Beyond the Age of the Great Stagnation , this ity in access to technology and information is going to deepen the inequality in skills , and ultimately , in wages and global standards of living . KEY CONCEPTS AND SUMMARY A public good has two key characteristics it is and . means that it is costly or impossible for one user to exclude others from using the good . means that when one person uses the good , it does not prevent others from using it . Markets often have a difficult time producing public goods because free riders will attempt to use the public good without paying for it . The free rider problem can be overcome through measures to assure that users of the public good pay for it . Such measures include government actions , social pressures , and specific where markets have discovered a way to collect payments . SELF CHECK QUESTIONS . Which of the following goods or services are ?

a police protection streaming music from satellite transmission programs roads . primary education cell phone service . Are the following goods in consumption ?

slice of pizza public radio a laptop computer ice cream cone REVIEW QUESTIONS . What are the two key characteristics of public goods ?

Name two public goods and explain Why they are public goods . What is the free rider problem ?

Explain why the federal government funds national defense .

544 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER CRITICAL THINKING QUESTIONS How do public television stations , like , try to overcome the free rider problem ?

Why is a football game on ESPN a good but a game on the , or ABC is a public good ?

Provide two examples of services that are classified as private services even though they are provided by a federal government . Radio stations , tornado sirens , light houses , and street lights are all public goods in that all are and . Therefore why does the government provide tornado sirens , street lights and light houses but not radio stations ( other than stations ) PROBLEMS Becky and Sarah are sisters who share a room . Their room can easily get messy , and their parents are always telling them to clean it up . Here are the costs and benefits to both Becky and Sarah , of taking the time to clean their room If both Becky and Sarah clean , they each spends two hours and get a clean room . If Becky decides not to clean and Sarah does all the cleaning , then Sarah spends 10 hours cleaning ( Becky spends ) but Sarah is exhausted . The same would occur for Becky if Sarah decided not to spends 10 hours and becomes exhausted . If both girls decide not to clean , they both have a dirty room . a . What is the best outcome for Becky and Sarah ?

What is the Worst outcome ?

It would help you to construct a prisoner dilemma table . Unfortunately , we know that the optimal outcome will most likely not happen , and that the worst one will probably be chosen instead . Explain what it is about Becky and Sarah reasoning that will lead them both to choose the worst outcome . REFERENCES , Tyler . Average Is Over Powering America Beyond the Age of the Great Stagnation . Dutton Adult , 2013 . Garret . The Tragedy of the Science 162 ( 3859 ) 1968 ) free rider those who want others to pay for the public good and then plan to use the good themselves if many people act as free riders , the public good may never be provided when it is costly or impossible to exclude someone from using the good , and thus hard to charge for it even when one person uses the good , others can also use it public good good that is and , and thus is difficult for market producers to sell to individual consumers

PRINCIPLES OF ECONOMICS 545 SOLUTIONS Answers to Questions Once citizens are protected from crime , it is difficult to exclude someone from this protection , so it is . Some satellite radio services , such as , are sold by subscription fee , so it is excludable . Once a road is built it is difficult to exclude people , although toll roads can exclude . Primary education can be provided by private companies and so it is excludable . Companies sell cell phone service and exclude those who do not pay . Two people can not enjoy the same slice of pizza at the same time , so private goods , such as a slice of pizza , are rivalrous . Two people can not use one laptop at the same time , so they are rivalrous in consumption . Public radio can be heard by anyone with a radio , so many people can listen at the same good is . It is difficult for two people to simultaneously eat an ice cream cone , so it is rivalrous in consumption .