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Public Goods
7.1
7.2
7.3
7.4

Optimal Provision of Public Goods

Private Provision of Public Goods
Public Provision of Public Goods
Conclusion

P R E PAR E D B Y

Dan Sacks
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C H AP T E R 7 P U B LI C G O O D S

Public Goods: Trash Collection

Why dont people pay to have their neighbors

trash collected?
No one wants to pay, but everyone wants
someone else to pay.
Private trash collection, financed by a
voluntary fee paid by neighborhood
residents, faces the classic free rider
problem.
Goods that suffer from this free rider
problem are known in economics as public
goods.
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7.1

C H AP T E R 7 P U B LI C G O O D S

Public Goods: A taxonomy

Pure public goods: Goods that are

perfectly non-rival in consumption and are
non-excludable.
Non-rival in consumption: One
individuals consumption of a good does not
affect anothers opportunity to consume the
good.
Non-excludable: Individuals cannot deny
each other the opportunity to consume a
good.
Impure public goods: Goods that satisfy
the two public good conditions (non-rival in
consumption and non-excludable) to some
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C H AP T E R 7 P U B LI C G O O D S

7.1

Defining Pure and Impure Public Goods

Is the good rival in

consumption?
Yes
Yes Private good
(ice cream)

Is the
good
excludab
No Impure public
le?
good
(crowded
sidewalk)

No
Impure public
good
(Cable TV)
Public good
(defense)

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7.1

C H AP T E R 7 P U B LI C G O O D S

Optimal Provision of Public Goods

How much of the public good should society

provide?
Markets will not provide the correct amount.
To answer this question, start by
reconsidering the market for a private
good, ice cream cones.
Ben and Jerry have different tastes for ice
cream (ic), relative to the other good (c).
How does the market aggregate their
preferences?

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7.1

C H AP T E R 7 P U B LI C G O O D S

Horizontal Summation in the Private Goods Market

Ben and Jerry demand different quantities

of the good at each price.
The optimality condition for the
consumption of private goods is written as:
Equilibrium on the supply side requires .
Therefore in equilibrium, .
marginal cost of production, equals
marginal benefit, or .

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C H AP T E R 7 P U B LI C G O O D S

7.1

Horizontal Summation in the Private Goods Market

Bens Marginal
Benefit

Price
of ice
cream
cone

Jerrys Marginal
Benefit

Price
of ice
cream
cone

Market
Price
of ice
cream
cone
S=
SMC

$2

DB

DJ

$2

$2

DB&J = SMB

Quantit
y of
cones

Quantit
y of
cones

Quantit
y of
cones

To find social demand curve, add quantity

at each pricesum horizontally.
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7.1

C H AP T E R 7 P U B LI C G O O D S

Optimal Provision of Public Goods

With public goods, such as missiles (m),

Bens consumption doesnt reduce Jerrys.
Therefore the social-efficiency maximizing
quantity solves
Social efficiency is maximized when the
marginal cost is set equal to the sum of the
MRSs, rather than being set equal to each
individuals MRS.

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C H AP T E R 7 P U B LI C G O O D S

7.1

Vertical Summation in the Public Goods Market

Price of
missiles

Bens marginal benefit

$2
1
0
Price of
missiles

DB
1

Quantity of
missiles

Jerrys marginal benefit

$4
2

DJ
0
Price of
missiles

Quantity of
missiles

Social marginal benefit and cost

$6

S=
SMC

DB&J = SMB
0

Quantity of
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7.2

C H AP T E R 7 P U B LI C G O O D S

Private Provision of Public Goods: Private-Sector

Under-Provision
The market does not produce the efficient
amount of public goods, because of the free
rider problem.
Free rider problem: When an investment
has a personal cost but a common benefit,
individuals will underinvest.
Since Bens consumption of missiles also
benefits Jerry, Jerry may not want to pay (or
vice versa).

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7.2

C H AP T E R 7 P U B LI C G O O D S

APPLICATION: The Free Rider Problem in Practice

The free rider problem is one of the most

powerful concepts in all of economics.
Radio and television programming:
o WNYC has an estimated listening
audience of about 1 million people, but
only 7.5% of their listeners support the
station.
o The United Kingdom uses a non-market
solution: The BBC charges an annual
licensing fee to anyone who owns and
operates a TV!
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7.2

C H AP T E R 7 P U B LI C G O O D S

APPLICATION: The Free Rider Problem in Practice

File sharing:
o 85% of users of a file sharing program
download files only from others.
o The file-sharing software Kazaa gives
download priority to users according to
their ratings, thus discouraging free
riders.
Bicycle shares:
o Users were expected to return each bike
riding.
o Within four days, not a single bicycle
was left.
o andLiteral
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7.2

C H AP T E R 7 P U B LI C G O O D S

Can Private Providers Overcome the Free Rider

Problem?
The free rider problem does not lead to a
complete absence of private provision of
public goods.
Plenty of private-sector TV programming
The private sector can in some cases
combat the free rider problem to provide
public goods by charging user fees that are
proportional to their valuation of the public
good.

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7.2

C H AP T E R 7 P U B LI C G O O D S

APPLICATION: Business Improvement Districts

Clean, safe sidewalks are public goods.

Cities attempt to provide them through
street repair and police work, financed with
tax revenue.
But New York Citys Times Square in the
1980s was a failure:
Dirty, dangerous, decrepit, and
increasingly derelict
In 1992, a group of private firms formed a
Business Improvement District to improve
the area themselves.
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7.2

C H AP T E R 7 P U B LI C G O O D S

APPLICATION: Business Improvement Districts

How did this BID work?
A (BID) is a legal entity that privately
provides local services and funds these
services with fees charged to local
businesses.
How do BIDs overcome free rider problem?
NYC law allows BIDs to levy fees on nonpaying members, as long as 60% of
members contribute.
Resounding success:
Crime has dropped significantly.
The area is cleaner and more attractive.
Business and tourism are booming.
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7.2

C H AP T E R 7 P U B LI C G O O D S

APPLICATION: Business Improvement Districts

Resounding success:
Crime has dropped significantly.
The area is cleaner and more attractive.
Business and tourism are booming.
Success of BIDs depends on the legal
underpinnings: Can members charge fees
to encourage payment?

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7.2

C H AP T E R 7 P U B LI C G O O D S

When Is Private Provision Likely to Overcome

the Free Rider Problem?
Markets

can (mostly) overcome the free rider

problem when some Individuals care more
than others.
Suppose Ben cares much more about
fireworks than Jerry.
Then Ben will want to buy a lot of fireworks
for himself ).
And the efficiency loss is not too great (.

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7.2

C H AP T E R 7 P U B LI C G O O D S

Altruism and social capital.

Private markets provide public goods when

people are altruistic.
Altruistic: When individuals value the
benefits and costs to others in making their
consumption choices.
Many laboratory experiments provide
evidence for altruism and show that people
contribute to public goods.
How altruistic people are is measured by
social capital.
Social capital: The value of altruistic and
communal behavior in society.
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7.2

C H AP T E R 7 P U B LI C G O O D S

Warm Glow

People might simply feel good about

contributing to public goods or charity.
Warm glow model: A model of the public
goods provision in which individuals care
about both the total amount of the public
good and their particular contributions as
well.
Different from altruism because people
dont care about just the amount of the
public good.

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7.3

C H AP T E R 7 P U B LI C G O O D S

Public Provision of Public Goods

Despite private provision, there is a role for

government provision of public goods:
Under private provision, not everyone
contributes to the good, even though
everyone benefits.
Government provision potentially solves the
problem of non-contributors.
Nonetheless, there are several challenges
to government provision.

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7.3

C H AP T E R 7 P U B LI C G O O D S

Private Responses to Public Provision: The Problem

of Crowd-Out
Crowd-out: As the government provides
more of a public good, the private sector
will provide less.
Warm glow: If people care about
contributions per se, they may continue to
contribute even when the government
contributes.
Evidence on crowd-out: Mixed.
o No evidence for full crowd-out
o No consensus on the size of this
important individual response to
government intervention
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7.3

C H AP T E R 7 P U B LI C G O O D S

EVIDENCE: Measuring Crowd-Out

The evidence on crowd-out is mixed.

Kingman (1989) looked at how
contributions varied as local governments
contributed different amounts to public
radio.
The study found that $1 increase in
government funding for public radio,
private contributions fell by 13.5.
Bias: Areas with high government
contribution could be high income, or have
a high taste for radio.
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7.3

C H AP T E R 7 P U B LI C G O O D S

EVIDENCE: Measuring Crowd-Out

Laboratory evidence seems more convincing.

In another study, individuals tokens to a
public good.
o A 2-token tax on every player was then
contributed to the public good.
o Without warm glow effects, players
should have reduced their contributions
by 2 tokens.
o However, each player cut his or her
contributions by only 1.43 tokens.
Unclear how well this result generalizes
outside of the lab, however.
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7.3

C H AP T E R 7 P U B LI C G O O D S

Measuring the Costs and Benefits of Public Goods

Optimal public good provision requires

knowing the MRS for each person. How to
measure this?
Consider the case of a highway. Cost
include wages and materials.
What if, without this highway project,
half of the workers on the project would
be unemployed?
How can the government take into
account that it is not only paying wages
but also providing a new job opportunity
for these workers?
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7.3

C H AP T E R 7 P U B LI C G O O D S

Measuring the Costs and Benefits of Public Goods

The benefits of highway construction are also

difficult to measure.
What is the value of the time saved for
commuters due to reduced traffic jams?
And what is the value to society of the
reduced number of deaths if the highway
is improved?

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7.3

C H AP T E R 7 P U B LI C G O O D S

How Can We Measure Preferences for the Public

Good?
Three challenges in measuring preferences for
public goods.
1. Preference revelation: People may not
want to reveal their true valuation because
the government might charge them more
for the good if they say that they value it
highly.
2. Preference knowledge: People may not
know what their valuation is.
3. Preference aggregation: How can the
government combine the preferences of
millions of citizens?
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7.4

C H AP T E R 7 P U B LI C G O O D S

Conclusion

A major function of governments at all

levels is the provision of public goods.
Sometimes, the private sector can provide
public goods, but usually not the optimal
amount.
Government intervention can potentially
increase efficiency.
Success of intervention depends on:
o Ability of government to measure costs
and benefits
o Ability to implement optimal plan
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