ECO Chapter 11 Notes – Public Goods and Common Resources PDF

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ECO CHAPTER 11 NOTES – Public Goods and Common Resources

Chapter Introduction     

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People do not pay a fee when they choose to enjoy the benefit of the good Goods without prices provide a special challenge for economic analysis Buyers pay for what they receive, sellers paid for what they provide  efficient allocation of resources Governments can sometimes improve market outcomes (remedy to market failure, raise economic well-being) Market failure – any situation in which unregulated markets fail to bring about a socially desirable outcome o Most common in competitive markets o Output level  MB = MC Left-wing people think they usually fail, right wing believe the opposite

The Different Kinds of Goods 

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A market can provide efficient # of ice-cream cones o Adjusts to balance of S & D o Equilibrium maximizes sum of producer and consumer surplus o Externalities affect this, though not taken into account Useful to group various goods in economy o Is the good excludable? Can people be prevented from using the good? o Is the good rival in consumption? Does one’s person’s use of good diminish another person’s ability to use it?

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Four different types of goods o Private Goods  Both excludable and rival in consumption  Ice cream  excludable because it is possible to prevent someone from eating one, rival in consumption because if one person eats one, another cannot eat the same one  Most goods are private in economy o Public Goods  Neither excludable, nor rival in consumption  People cannot be prevented from using, one person’s use doesn’t reduce another person’s ability to use it  Difference than private  lies mostly on the D side as opposed to the S side  Scarcity still exists, different types of governments account for 40% of all economic activity  NOT free goods, still economic as they incur an opportunity cost, financed from tax revenue o Common Resources  Rival in consumption, but not excludable  Fish in the ocean  are rival in consumption, but it is difficult to prevent a fisherman from taking fish out of the ocean o Club Goods  Excludable but not rival in consumption  Fire protection in a small town  easy to exclude someone, fire department can just let a house burn down, but once a town has paid for the fire department, additional cost of protecting one more cost is small o All 4 types hard to distinct  fishing an ocean may not be excludable because fish monitoring is difficult, but can be partly excludable We examine public goods and common resources, cannot be prevented from using these goods, available for everyone free of charge Positive externalities – receive a benefit without paying for it Negative externalities – suffer a loss and are not compensated for it

Public Goods 

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Fireworks display example o Not excludable but impossible to prevent someone from seeing fireworks o Not rival in consumption because one person’s enjoyment of fireworks doesn’t reduce anyone else’s The Free-Rider Problem o Town contains 500 residents, and each place a $10 value on the experience, for a total benefit of $5000  Cost of fireworks is $1000  Benefits > Costs, therefore, efficient o Fireworks not excludable  people have incentive to be free riders o Free Rider – person who receives benefit of a good but avoids paying for it

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 Government creates policies to make sure there aren’t a lot of free-riders o One way to view a market failure (if private) is because of externalities  Confers an external benefit on those who see without paying for it, not profitable, therefore makes the decision not to put on display o Government can sponsor the event, council can raise everyone’s taxes by $2 and use the revenue to hire Ellen to make the event (then becomes public) o Free riding = lying, not contributing to provision of public good according to one’s true preferences o Heavy users overstat preferences (knowing others paying for most of cost) o Light users understate preferences  Both tempted to avoid paying their share of tax burden o Solution  government financed by compulsory taxation o Any time you hear an interest group saying that more tax $ should be allocated to such and such purpose  public good type argument Some Important Public Goods o National Defence  Once country is defended, impossible to prevent anyone from enjoying the benefit of this defence, neither does it reduce benefit of anyone else  2014 Canadian government spent $21.5 billion, 2011 US spent $717 billion o Basic Research  Knowledge created through research  Distinguish general knowledge from specific knowledge  Specific can be patented  gives the inventor the exclusive right to the knowledge, anyone who wants to use the information must pay the inventor  General = public good (ex. math theorems)  Research provided by government (public)  Don’t be surprised if public sector fails to pay for the right amount and right kinds o Fighting poverty  Welfare programs provide some income, subsidized housing, tax system (refundable tax credits) for low-income individuals  Fighting poverty not a good that private actions will adequately provide  One person’s enjoyment of living in a society without poverty, doesn’t reduce other’s  Once poverty is eliminated, no one can be prevented from taking pleasure in this fact  People of poverty are helped by tax from wealthy, wealthy benefit from living in a society with less poverty The Difficult Job of Cost-Benefit Analysis o Government provides public goods because private market will not produce an efficient quantity o Government must decide what goods and how much  Though many mixed and public goods may be overproduced (MC > MB)

o Cost-Benefit Analysis – estimate total costs and benefits of project to society as a whole  Tough job in evaluating benefits  Incentives  people who use it exaggerate benefit they receive, people who harmed exaggerate the costs to them  Compulsory taxation solves this, increase production level closer to optimal level o Private goods easy to evaluate, equilibrium is efficient allocation because it reflects all information of costs and benefits

Common Resources   

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Non-excludable, available free of charge to anyone who wants to use them Rival in consumption (in the absolute extreme), one person’s use reduces another person’s ability to use it Tragedy of the Commons o Once good is provided, policymakers need to be concerned about how much is used o Small medieval town  Most important is raising sheep  Sheep graze all over land, no one owns the land, town residents own land collectively  Therefore, anyone can use the land for their sheep to graze (no rival in consumption  Growing population and sheep, limited amount of land  Eventually no land left, families lose their source of livelihood  result of externality  Though, if shepherds acted together, could reduce sheep population that town can support, but no one does because each flock represents small part of problem  Town can divide land among town families  land becomes private, not common anymore o General lesson  one person uses common resource, they diminish other people’s enjoyment of it  Because of this negative externality, incentive for common resources to be used excessively/over exploited and little incentive to invest o Lack of assigned property rights is the heart of the externality and public good problem  Government can solve problem by using regulation, taxes, or turning common into private (property rights – the owner has the ability to use it as he/she sees fit) Some Important Common Resources o Clean Air and Water  Markets do not protect environment  Pollution remedied with regulations or corrective taxes used on polluting activities  Clean water = common resource, excessive pollution = excessive grazing

o Congested Roads  If road not congested, one person’s use doesn’t affect anyone else’s = public good  If congested, then use of road yields a negative externality = common resource  Usually larger during rush hour  When one additional person uses road, becomes more crowded, people must drive more slowly  Charge drivers a toll to avoid/reduce congestion  Tax on gasoline (complementary good with driving), larger tax = less congestion o Fish, Whales, and Other Wildlife  Many species are common resources, fish have commercial value  Hard to regulate, oceans are so big, countries connected, enforcing agreement difficult  Fishing licenses, required to throw back small fish, limit of collected fish

Conclusion: The Importance of Property Rights   

Societies rely on government to protect environment and provide for national defence Absence of property rights causes market failure, government can solve this If policy well planned and well run = efficient allocation of resources, thus raise economic well-being

Textbook Summary 

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Goods differ in whether they are excludable and whether they are rival in consumption. A good is excludable if it is possible to prevent someone from using it. A good is rival in consumption if one person’s use of the good reduces other’s ability to use the same unit of the good. Markets work best for private goods, which are both excludable and rival in consumption. Markets do not work as well for other types of goods. Public goods are neither rival in consumption nor excludable. Examples of public goods include fireworks displays, national defence, and the creation of fundamental knowledge. Because people are not charged for their use of the public good, they have an incentive to free-ride, making the private provision of the good untenable. Therefore, governments provide public goods, making their decision about the quantity based on cost–benefit analysis. Common resources are rival in consumption but not excludable. Examples include common grazing land, clean air, and congested roads. Because people are not charged for their use of common resources, they tend to use them excessively. Therefore, governments try to limit the use of common resources....