Public Goods Flashcards
Utility and indifference curves
The higher the indifference curve, the higher the utility and the higher the level of satisfaction
Indifference curve
Gives the combination of goods which an individual is indifferent or which yield the same level of utility
Has a decreasing gradient due to the decreasing marginal rate of substitution. This means that when an individual has more of good A, fewer quantities of good B are required to compensate him.
Budget constraint
Mathematical representation of all the combinations of goods an individual can afford given their income and the price of the goods.
Slope of the budget constraint curve is equal to the ratio of the prices
Relationship between the budget constraint and indifference curves
Consumers want to be on the highest indifferent curve in order to reap the highest utility but this is not possible for points that lie above the budget constraint. As a result, the consumer chooses the point along the budget constraint curve that he most prefers using the indifference curves. An individual can only afford goods where the budget constraint curve is tangent to the indifference curve.
Supply curve
Upward sloping curve due to profit motives
Demand curve
The lower the price, the greater the quantity demanded - income effect
When is efficiency not met
Market failure/Failure of competition
Public goods and common pool resources
Externalities
Oligopolies and Monopolies
Explain why efficiency is not met under imperfect competition
Pareto efficiency is met when there is perfect competition where price = marginal cost, in other words, society’s valuation of the last unit of good produced is equal to the opportunity cost of producing it. This entails stringent conditions including exchange, production, product mix efficiency which are only met when firms are price takers.
Consumer surplus
Difference between the actual price and maximum price consumers are willing to pay for
Producer surplus
Difference between the price at which the good is supplied and the price producers were willing to supply the good for
Total surplus
Consumer + Producer surplus
Public goods
Public goods are non-excludable and non-rivalrous in consumption.
Non-excludability: The cost of excluding an individual from enjoying the good is prohibitively high. Since those who do not pay cannot excluded from benefiting, no one has much incentive to pay for the good, resulting in the free-rider problem. With the absence of effective demand, there are no price signals which is what profit–maximisng firms use to produce a good.
Non-rivalry: Consumption of the good by one person does not reduce the amount or benefits available to others. Once provided, the supply of a public good is not depleted by an additional user, making the marginal cost of providing for an additional user in the usage of the good or service zero. since allocative efficiency is achieved when P = MC, and the MC of providing the good is 0, the price of the good should be 0 for Pareto efficiency to be achieved. Since no profit-maximising producer will charge the good at zero-price, there will be no supply.
Free-rider problem
Due to non-excludability and non-rivalrous, there is no incentive to pay and no one would voluntarily do so → no incentive to be provided, due to no profit → under/no supply → Gov provide those goods and can force us to pay for them (indirectly through taxation)
Optimal level of provision of public goods
Problem of provision of public goods
Difficult to decide the optimal level of provision of public goods because:
a) Distortionary effects of taxation
b) Governments may also provide impure public goods such as those that are excludable but non-rivalrous or non-excludable but rivalrous including publicly providing private goods such as education and healthcare because it sees the value in providing these to society
c) Overconsumption: For many publicly provided goods, consumption is to some extent rivalrous (water supply) or excludable (roads) or both (healthcare), if provided free of charge, there is a risk of overconsumption.
