Property Rights Property Rights and Public Goodsand Public GoodsProperty Rights Property Rights

and Public Goodsand Public Goods

Overview• Externalities and Property Rights

– Recycling

• Common Property Resources

• Public Goods & Private Preferences for Public Goods

• Benefit-cost Analysis

• Public Choice Process

The Efficient Amount of Recycling

Scrap

Cost

0 4 8 12

MCR

MSC

m*

With a refundable deposit,MC increases andMC = MSC = MCR.

MC + per unit refundMC

m1

Without market interventionthe level of scrap will be at m1

and m1 > m*.Households can dispose of glass and other garbage at very low cost. The low cost of disposal creates a divergence between the private and the social cost of disposal. S0, raising MC is a move in the right direction.

Extent of recycling

Refund is like a tax for non-compliance, but no tax if there is compliance

Refundable Deposits

Amount of Glass

$

D

Price falls to P’ and the amount of recycled glass increases to M*.

Sv

Sr

S

The supply of glass S is the horizontal sum of the

Supply of virgin glass (Sv)

and the supply of recycled

glass (Sr).

M1

P

Without refunds the price of glass is P and

Sr is M1.

S’r

S’

P’

M*

With refunds Sr increasesto S’r and S increases to S’.

Externalities and Property Rights

• Property Rights– Legal rules describing what people

or firms may do with their property– For example

• If residents downstream owned the river (clean water) they control upstream emissions.

• Bargaining and Economic Efficiency– Economic efficiency can be achieved

without government intervention when the externality affects relatively few parties and when property rights are well specified.

PRIVATE SOLUTION TO EXTERNALITIES

• Coase Thorem: Economic agents can arrive at an efficient solution (i.e., an optimum assignment of property rights)– irrespective of initial assignment of property

rights, – provided they can bargain free of cost (i.e., w/o

transaction costs), and – there is no wealth effect to thwart the

bargaining process.• Coase Theorem at Work: Negotiating an Efficient

Solution - 1987 --- New York garbage spill (200 tons) littered the New Jersey beaches– The potential cost of litigation resulted in a

solution that was mutually beneficial to both parties.

Coase Theorem

MC of pollution to MC of pollution to fisheriesfisheries

MC of pollution MC of pollution abatement by factoryabatement by factory

PollutionPollution Abatement Abatement

AA

CC

BB

EE O’O’OO FF

LL

XX

OE is optimal quantity of pollution and O’E is the corresponding optimal quantity of abatement

At E, the marginal costs of pollution and abatement are equal, and the sum of the total costs i.e. triangle OXO’ is the least

At A, MC of abatement exceeds MC of pollution, so it is cheaper to compensate the fishermen AB than to abate the pollution AC

Demand price for abatement falls short

Demand price forabatement now higher to facilitate pollution reduction

Common Property Resources

• Common Property Resource– Everyone has free access.– Likely to be over-utilized– Examples

• Air and water• Fish and animal populations• Minerals

• Solution– Private ownership

• Question– Wouldn’t private ownership be

impractical?

Common Property Resources

Fish per Month

Benefits,Costs($ per

fish)

Demand

However, private costsunderestimate true cost.

The efficient level of fish/month is F* where

MSC = MB (D)

Marginal Social Cost

F*

Private Cost

FC

Without control the numberof fish/month is FC where

PC = MB (marginal benefit).

Crawfish Fishing in Lousiana

• Finding the Efficient Crawfish Catch– F = crawfish catch in millions of pounds/yr– C = cost in dollars/pound

• Demand– C = 0.401 = 0.0064F

• MSC– C = -5.645 + 0.6509F

• PC– C = -0.357 + 0.0573F

• Efficient Catch– 9.2 million pounds– D = MSC

Crawfish Catch(millions of pounds)

CCost

(dollars/pound)

Demand

Marginal Social Cost

Private Cost

Crawfish as a CommonProperty Resource

11.9

2.10

9.2

0.325

Public Goods• Public Good Characteristics

– Non-rival• For any given level of production the

marginal cost of providing it to an additional consumer is zero.

– Non-exclusive• People cannot be excluded from

consuming the good.

• Not all government produced goods are public goods– Some are rival and non-exclusive (more

like a common property resource)

• Education

Typology of Goods

Characteris-tics

ExcludableNon-

excludable

Rival Private GoodCommon Property Resource

Non-rival Club Good Public Good

D1

D2

D

When a good is non-rival, the social marginalbenefit of consumption (D) , is determined by

vertically summing the individual demand curves for the good.

Efficient Public Good Provision

Output0

Benefits(dollars)

1 2 3 4 5 6 7 8 109

$4.00

$5.50

$7.00

Marginal Cost

$1.50

Efficient output occurswhere MC = MB at 2

units of output. MB is$1.50 + $4.00 or $5.50.

Horizontal sum of demand curves

What if this is the MC curve?

Problem with Public Goods

• Free Riders– There is no way to provide some goods

and services without benefiting everyone.– Households do not have the incentive to

pay what the item is worth to them.– Free riders understate the value of a good

or service so that they can enjoy its benefit without paying for it.

• Clean Air is a public good– Non-exclusive and non-rival

• What is the price of clean air?

How to know Private Preferences for Public

Goods?

• Government production of a public good is advantageous because the government can assess taxes or fees to pay for it.

• Determining how much of a public good to provide when free riders exist is however extremely difficult.

The Demand for Clean Air

Nitrogen Oxides (pphm)0

Dollars

1 2 3 4 5 6 7 8 109

2000

2500

3000

500

1500

1000

Low Income

Middle Income

High Income

Findings on Demand for Clean Air

– Amount people are willing to pay for clean air increases substantially as pollution increases.

– Higher income earners are willing to pay more (the gap between the demand curves widen)

– National Academy of Sciences found that a 10% reduction in auto emissions yielded a benefit of $2 billion---somewhat greater

than the cost.

Exercise 7, p.653: Willingness to pay for different quantities of the public

good

Time G-1 G-2 G-3 V.Sum

0 150 200 250 60050 100 100 200 400100 50 0 150 200150 0 0 100 100200 0 0 50 50250 0 0 0 0

Exercise 7, p.653: Willingness to demand the private good at different

prices

Price G-1 G-2 G-3 H.Sum

250 0 0 0 0200 0 0 50 50150 0 25 100 125100 50 50 150 25050 100 75 200 3750 150 100 250 500

Benefit-cost Analysis• Compares present value of benefits to present

value of costs of a government project, which is mostly in the nature of public goods

• Helps ranking projects in terms of benefit-cost ratio (must be >1) until available limited resources are exhausted

• Difficulties in BC ratio estimation:– Correctly estimating benefits & costs in the future,

especially their opportunity costs– Many benefits and costs - often in the nature of

intangibles - are not quantifiable– Choice of interest rate for discounting poses a very

serious problem & hence sensitivity analysis is performed to choose across different alternative rates

• Hence, BC analysis still a subjective art rather than an objective science

Public Choice ProcessBroad groups Major characteristics1. Voters Voting for policies favoring their interests

Generally less informed about political decisions than their market decisions – referred to as ‘rational ignorance’

- less need to gather information as elected leaders are empowered to take decisions on their behalf

- very expensive to gather information on public choice

- voters have less influence on and lesser affected by public choice as compared to market choice

2. Politicians As counterpart of firm entrepreneurs/managers, seek to maximize chance of re-election

Often responds to desires of small, well-organized, well-informed, well-funded, passionate & vocal interest groups at the cost of mostly silent and uninformed majority

Public Choice ProcessBroad groups Major characteristics3. Interest groups Organize lobbies and support

politicians willing to serve their interests, although laws & regulations are invariably rationalized in terms of national interest

4. Bureaucrats Often implements policies under monopoly conditions w/o caring for efficiency, unless there is pressure of competition to compete and coordinate

Often non-neutral and non-passive, actively trying to influence

policy & its implementation Hence as a special interest group

within government contributes to size & growth of the bureau

Some Institutional Changes Suggested to prevent ‘Government Failure’

• Informing, educating & organizing voters

• Contracting out government services not entirely public good in nature

• Encouraging inter-agency competition

• Referendum & thus frequently reverting to direct democracy

• Specify total amount of funds to be allocated across competing uses.