Public Goods and Common Resources

CHAPTER11

C H A P T E R C H E C K L I S T

When you have completed your study of this chapter, you will be able to

1 Distinguish among private goods, public goods, and common resources.

2 Explain the free-rider problem and how public provision can help to overcome that problem.

3 Explain the tragedy of the commons and review the possible solutions to that problem.

11.1 CLASSIFYING GOODS AND RESOURCES

What is the essential difference between:• A city police department and Brink’s security• Fish in the Pacific Ocean and fish in a fish farm• A live concert and a concert on television

These, and all goods and services, can be classified according to whether they are excludable or nonexcludable and rival or nonrival.

Excludable

A good, service, or resource is excludable if it is possible to prevent a person from enjoying its benefits.

A good, service, or resource is nonexcludable if it is impossible to prevent a person from benefiting from it.

11.1 CLASSIFYING GOODS AND RESOURCES

Examples of excludable items are• The security services of Brink’s• Fish in a fish farm• A live concert

Examples of nonexcludable items are• The services of the city police department• Fish in the Pacific Ocean• A concert on network television

11.1 CLASSIFYING GOODS AND RESOURCES

11.1 CLASSIFYING GOODS AND RESOURCES

Rival

A good, service, or resource is rival if its use by one person decreases the quantity available to someone else.

A good, service, or resource is nonrival if its use by one person does not decrease the quantity available to someone else.

Examples of rival items are• The services of Brink’s security• Fish both in ocean and in a fish farm• A seat at a live concert

Examples of nonrival items are• The protection provided by a city police

department• A concert on network television

11.1 CLASSIFYING GOODS AND RESOURCES

11.1 CLASSIFYING GOODS AND RESOURCES

Private Goods

A private good is a good or service that can be consumed by only one person at a time and only by those people who have bought it or own it.

A private good is both rival and excludable.

For example, a can of coke.

A Fourfold Classification

11.1 CLASSIFYING GOODS AND RESOURCES

Public Goods

A public good is a good or service that can be consumed simultaneously by everyone and no one can be excluded from enjoying its benefits.

It is both nonrival and nonexcludable.

For example, a flood-control levee.

11.1 CLASSIFYING GOODS AND RESOURCES

Common Resources

A common resource is a resource that can be used only once but no one can be prevented from using what is available.

It is both rival and nonexcludable.

For example, fish in the Pacific Ocean.

11.1 CLASSIFYING GOODS AND RESOURCES

Natural Monopoly

A good or service that is both nonrival and excludable is produced by a natural monopoly.

A natural monopoly is a firm that produces at lower cost than two or more firms can.

Figure 11.1 shows this fourfold classification of goods and services.

11.1 CLASSIFYING GOODS AND RESOURCES

Public goods create a free-rider problem.

A free rider is a person who enjoys the benefits of a good or service without paying for it.

Because of the free-rider problem, the market would provide too small a quantity of a public good.

To produce the efficient quantity, government action is required.

11.1 PUBLIC GOODS11.2 PUBLIC GOODS AND FREE-RIDER PROBLEM

The Free-Rider Problem

The benefit a public good provides is the value of its services.

Because security lights in a common parking area are nonrival and nonexcludable, they are a public good.

• Everyone consumes the same quantity of them.

To find the economy-wide value of the security lights, we add together the marginal benefits of everyone who benefits from them.

The Marginal Benefit of a Public Good

11.2 PUBLIC GOODS AND FREE-RIDER PROBLEM

Figure 11.2 shows how to find an economy’s MB curve.

Lisa’s marginal benefit curve is MBL.

The MB curve for the economy is the vertical sum of the marginal benefit curves of everyone in the economy—Lisa and Max.

Max’s marginal benefit curve is MBM.

11.2 PUBLIC GOODS AND FREE-RIDER PROBLEM

Marginal cost increases as the quantity of a public good produced increases—the principle of increasing marginal cost.

So the marginal cost curve of public good slopes upward.

The Marginal Cost of a Public Good

11.2 PUBLIC GOODS AND FREE-RIDER PROBLEM

The Efficient Quantity of a Public Good

Resources are used efficiently if marginal benefit equals marginal cost.

If marginal benefit exceeds marginal cost, resources can be used more efficiently by increasing the quantity produced.

If marginal cost exceeds marginal benefit, resources can be used more efficiently by decreasing the quantity produced.

11.2 PUBLIC GOODS AND FREE-RIDER PROBLEM

Figure 11.3 shows the efficient quantity of a public good—surveillance satellites.

1. If MB exceeds MC, an increase in the quantity will make resource use more efficient.

2. If MC exceeds MB, a decrease in the quantity will make resource use more efficient.

11.2 PUBLIC GOODS AND FREE-RIDER PROBLEM

3. If MB equals MC, resource use is efficient.

4. The efficient quantity is 200 satellites.

5. Private provision leads to underproduction—in the extreme, to zero production.

11.2 PUBLIC GOODS AND FREE-RIDER PROBLEM

No one would have an incentive to buy his or her share of the satellite system—the free-rider problem.

So a private firm would not supply satellites.

Private Provision: Underproduction

The political process determines the quantity of a public good provided—this quantity might be efficient or inefficient.

Public Provision: Efficient Production

11.2 PUBLIC GOODS AND FREE-RIDER PROBLEM

Figure 11.4(a) shows the preferences of two political parties in an election.

1. Doves would like to provide 100 satellites.

2. The Hawks would like to provide 300 satellites.

11.2 PUBLIC GOODS AND FREE-RIDER PROBLEM

Figure 11.4(b) shows an efficient political outcome.

3. The political outcome is 200 satellites because, unless each party proposes 200 satellites, the other party can beat it in the election.

11.2 PUBLIC GOODS AND FREE-RIDER PROBLEM

The principle of minimum differentiation is the tendency for competitors to make themselves identical to appeal to the maximum number of clients or voters.

Principle of Minimum Differentiation

11.2 PUBLIC GOODS AND FREE-RIDER PROBLEM

Bureaucrats translate the choices of politicians into programs and control the day-to-day activities that deliver public goods.

The behavior of bureaucrats modifies the political outcome.

Public Provision: Overproduction

11.2 PUBLIC GOODS AND FREE-RIDER PROBLEM

Objective of BureaucratsThe bureau’s goal is to maximize its budget.

1. The efficient quantity is 200 satellites.

11.2 PUBLIC GOODS AND FREE-RIDER PROBLEM

If the bureau is successful in the pursuit of its goal, the politicians provide 300 satellites.

2. With 300 satellites, marginal cost exceeds marginal benefit.

3. With 300 satellites, inefficient overproduction occurs.

11.2 PUBLIC GOODS AND FREE-RIDER PROBLEM

Why don’t the politicians block the bureaucrats?

Rational Ignorance

Rational choice balances marginal benefit and marginal cost.

An implication of rational choice is rational ignorance.

Rational Ignorance is the decision not to acquire information because the marginal cost of doing so exceeds the expected marginal benefit.

11.2 PUBLIC GOODS AND FREE-RIDER PROBLEM

Part of the reason why government is large is • Inefficient overprovision of public goods• Voters’ rational ignorance

Once a bureaucracy gets established, its goal of budget maximization combined with voters’ rational ignorance explains why government takes a large proportion of total income.

Why Government Is Large

11.2 PUBLIC GOODS AND FREE-RIDER PROBLEM

11.3 COMMON RESOURCES

The Tragedy of the Commons

The tragedy of the commons is the absence of incentives to prevent the overuse and depletion of a commonly owned resource.

Examples include the Atlantic Ocean cod stocks, South Pacific whales, and the quality of the earth’s atmosphere.

The traditional example from which the term derives is the common grazing land surrounding middle-age villages.

Figure 11.6 illustrates the sustainable production of fish.

As the number of fishing boats increases, the sustainable quantity of fish caught increases to some maximum and then decreases.

Beyond that maximum sustainable catch, there is overfishing.

11.3 COMMON RESOURCES

Figure 11.7 shows why overfishing occurs.

1. The average catch per boat, which is the marginal private benefit, MB, decreases as the number of boats increases.

2. The marginal cost per boat is MC (assumed constant).

11.3 COMMON RESOURCES

3. Equilibrium occurs where marginal private benefit, MB, equals marginal cost, MC.

The equilibrium number of boats fishing is 8,000 and overfishing occurs.

Overfishing occurs because no one takes into account the effects of her/his actions on other users of the resource.

11.3 COMMON RESOURCES

11.3 COMMON RESOURCES

The Efficient Use of the Commons

The quantity of fish caught by each boat decreases as the number of boats increases.

But no one has an incentive to take this fact into account when deciding whether to fish.

The efficient use of a common resource requires marginal cost to equal marginal social benefit.

Marginal Social Benefit

Marginal social benefit is the increase in total fish catch that results from an additional boat.

The marginal social benefit is not the average catch per boat, which is the marginal private benefit.

Table 11.1 on the next slide shows the calculation of marginal social benefit.

11.3 COMMON RESOURCES

Boats Total Catch MSB

A 0 0

90

B 1 90

70

C 2 160

50

D 3 210

30

E 4 240

11.3 COMMON RESOURCES

Efficient Use

Figure 11.8 illustrates the efficient use of a common resource.

1. At each number of boats, the marginal social benefit curve, MSB, is below the MB curve.

2. The resource is used efficiently when MSB equals MC.

11.3 COMMON RESOURCES

Achieving an Efficient Outcome

It is harder to achieve an efficient use of a common resource than to define the conditions under which it occurs.

Three methods in use are• Property rights• Quotas• Individual transferable quotas (ITQs)

11.3 COMMON RESOURCES

11.3 COMMON RESOURCES

Property Rights

By assigning property rights, common property becomes private property.

When someone owns a resource, the owner is confronted with the full consequences of her/his actions in using that resources.

The social benefits become the private benefits.

Figure 11.8 shows that with property rights,

1. The marginal social benefit curve, MSB, becomes the marginal private benefit curve.

2. The resource is used efficiently because the owner of the resource is best off when MSB equals MC.

11.3 COMMON RESOURCES

Quotas

By setting a production quota at the efficient quantity, a common resource might remain in common use but be used efficiently.

Figure 11.9(a) shows this situation.

It is hard to make a quota work.

11.3 COMMON RESOURCES

Individual Transferable Quotas

An individual transferable quota (ITQ) is a production limit that is assigned to an individual who is free to transfer the quota to someone else.

A market emerges in ITQs.

If the efficient quantity of ITQs is assigned, the market price of a quota confronts resource users with a marginal cost that equals MSB at the efficient quantity.

11.3 COMMON RESOURCES

Figure 11.9(b) shows the situation with an efficient number of ITQs.

The market price of an ITQ increases the marginal cost from MC0 to MC1.

Users of the resource make marginal private benefit, MB, equal to marginal private cost, MC1, and the outcome is

efficient.

11.3 COMMON RESOURCES