Public Goods

Market Failure = when a market fails to deliver an efficient allocation of resources

Economists have determined that there are 3 main reasons why a market might fail1. Presence of Externalities (Spillovers)2. Presence of imperfect information3. The Provision of Public Goods

Market Failure

A public good = a good or service that can not be provided to one person, without also being provided to another

A public good has two characteristics: Nonrivalry Nonexcludability

Public goods

Nonrivalry = More consumption of a good by one person does not mean less consumption of the same good by someone else Example: national defense system

The moment a child is born, she benefits from the national defense system without anyone else having to give it up

Example of a good with rivalry in consumption: Hamburgers If you eat one, that means there is one less for

everyone else (or more burgers must be made)

Nonrivalry

Nonexcludability = One person can not exclude others from consuming a good

For example: National Defense. In contrast, most goods have the

characteristic of excludability Example: Hamburgers. If you don’t pay for it,

the server won’t give it to you Can you think of a good that satisfies both

nonrivalry, and nonexcludability?

Nonexcludability

In the case of public goods, even those who have not contributed to the provision of the good or service can still benefit from it

For example, everyone benefits from the protection provided by the police. One person’s protection does not come at the expense of another’s No one can be excluded from enjoying the protection

Therefore, it would be difficult for a private company to provide this service. How would you bill your customers?

Therefore, the government provides the public good, and taxes all citizens to cover costs

Free-Rider Problem

Not all public goods are provided by the government and paid for through taxes

The classic example is lighthouses used to warn ships of the shoreline Why would this be considered a public good?

Early lighthouses were built by private shipping firms They collected user fees from ships that made it to any

nearby port Therefore, the free-rider problem was avoided, and a

general tax was not needed Some other examples of user fees are national parks

Free-Rider Problem

Both of the following are examples of public goods Radio Satellite Television

They satisfy both of the criteria: nonrivaly and nonexcludability

However, they are both produced primarily by private firms

How do these firms avoid the free-rider problem?

Free-Rider Problem

Just because a good is produced by the government, it does NOT make it a public good.

For example: education. Additional students might actually reduce the

education of students already in the class. There are ways to exclude people from education

However, education is often discussed as a public good in certain contexts

For an economist, to be considered a public good it MUST satisfy the two main criteria

Government and Public Goods

Assume that a certain good or service IS a public good, how will the government decide how mush of it to produce, or if it should be produced at all? Which key economic principle do economists use?= Marginal Principle!

The government must compare the costs and benefits of providing the public good

Government and Public Goods

Consider: A city government must decide whether or not to increase the size of it’s police force

Marginal Benefit … The reduction in loss of life and property

Marginal Cost … The increase in police payroll

Simply apply the marginal principle. If the benefit > cost, then increase the police force BUT, measuring the marginal benefit is often very

difficult to do for public goods

Government and Public Goods

How could you measure the marginal benefit people in a city receive from police services? Brainstorm a list of as many ways as possible

One way is called contingent valuations = discover people’s willingness to pay through

surveys, polls, and questionnaires Not always reliable, since people may not give an

accurate estimate of their willingness to pay (especially if they never have to actually pay for it)

Government and Public Goods

Choose one of the public goods listed below, and write a creative short story that describes a future world where the public good does not exist. Police Services Road Construction Clean Air

Your short story must include the following elements Explain why this good is considered public Describe why the public good no longer exists Describe the potential consequences for you and other

citizens of the future world now that this good is no longer provided

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