EMI4- Public Goods Flashcards
- Define a public good
- What does this mean?
- Give examples
- A good that it is non-rivalrous.
- This means that if one agent in an economy consumes a unit of the public good it doesn’t reduce the amount available to other agents in the economy
- National defence/Fresh air
- Define a pure public good
- What does this mean?
- Give examples
- A good that is non-rivalrous and non-excludable
- Non-excludability means that it is not possible to prevent agents from consuming the good.
- National defence/Fresh air
• Define a pure private good
• A good that is rivalrous and excludable
Explain public good externalities
- An individual agent supplies a public good for his own consumption, so the rest of society benefits. This is a positive externality
- However if the individual doesn’t take into account the benefit to others, there will be an under provision of this good, leading to market failure
Why can an individual not successfully charge people for the public good that they provide?
• As public goods are non-excludable, so free-riding will occur.
Where will the highest valuing individual optimally choose to purchase Q*?
Where their Marginal Valuation = Marginal Cost
- In Public Good externality, who will provide the public good?
- Why?
- The highest valuing individual
- All other individuals can already consumer what the highest valuing has purchased, so there’s no benefit to purchasing any more, ie they will free ride.
Where does the equilibrium of provision for the public good lie?
At the same point as the provision for the highest value individual.
At what point is the Pareto efficient outcome?
Where the sum of all the individual’s marginal valuation = the marginal cost
Is a private solution to the provision of the public good Pareto efficient?
No, as Q*
With 2 goods 1 and 2, what does MRS12=?
MRS12 = MU1/MU2 = P1/P2 = MC1/MC2 = MRT12
What is the formula required for Pareto efficiency?
MRS12 = ∑MUi = MC1 = MRT12
What is the Lindahl price?
This is the price charged to each individual for their consumption of the public good, and is equal to each individual’s marginal valuation
What are the 2 main issues with a Lindahl market?
- As marginal valuations are not observable, the dominant strategy is to understate your marginal valuation in order to pay a lower Lindahl price
- There is going to need to be a mechanism to exclude or penalise those who do not pay, which is difficult as public goods are often non-excludable
How does the Vickrey-Clarke-Groves (VCG) Mechanism work?
- Identify the individuals who’s reservation value would be enough to change the optimal decision from not providing the public good to providing the public good
- Tax these individuals enough so that they are incentivised to reveal their true valuations
- Therefore, the pivotal individuals are incentivised to reveal their true valuations and pay a tax, and no one else has an incentive to lie about their valuations, so the good is provided optimally.
