Topic 2: Public Goods

Question 1

Pure public goods

Answer 1

Goods that are perfectly non-rival in consumption and are non-excludable

Question 2

Non-rival in consumption

Answer 2

One individual’s consumption of a good does not affect another’s opportunity to consume the good

Question 3

Non-excludable

Answer 3

Individuals cannot deny each other the opportunity to consume a good

Question 4

Horizontal summation

Answer 4

To find the social demand curve in the private goods market add quantity at each price (Q = q1 +q2 - summing demand curves)

Question 5

Optimal provision of private goods

Answer 5

MRSa = MRSb = MC

Question 6

Equation for MRSx,y

Answer 6

MRSx,y = MUx / MUy (social efficiency is maximised when the MC is set equal to each individual MRS)

Question 7

Vertical summation

Answer 7

To find the social demand curve in the public goods market add price at each quantity (P=p1+ p2 - sum inverse demand curves)

Question 8

Optimal provision of public goods

Answer 8

MRSa + MRSb = MC (social efficiency is maximised when the MC is set equal to the sum of the MRS)

Question 9

Samuelson Rule

Answer 9

With public good provision, social efficiency is maximised when the MC is set equal to the sum of the MRSs

Question 10

Government’s maximisation problem in public good provision

Answer 10

max weighted sum of individuals utility functions subject to the aggregate resource constraint (solve with Lagrangian)

Question 11

Problem with private provision of public goods

Answer 11

Consumers can free ride on the firm, which undertakes all the costs, so the only possible level of production for the firm to avoid losses is 0 (suboptimally low!)

Question 12

Free riding problem

Answer 12

when an investment has a personal cost but a common benefit, individual have an incentive to underinvest

Question 13

Why is NE of public good provision not pareto efficient?

Answer 13

When each agent buys an additional unit of the public good, they have a positive external effect on the other agents which they do not take into account (other agents free ride)

Question 14

Why is Samuelson rule difficult to achieve through public intervention in practice?

Answer 14

1. Government must be a benevolent social planner (cannot have own utility to consider)
2. Government needs to know preferences or have a mechanism to reveal preferences (to understand how to aggregate and translate into proper SWF)
3. Issue of how to finance if only distortionary taxes available

Question 15

Lindahl pricing

Answer 15

Price is modified in two ways:
1. Adjusts price of public good to align social and private benefits
2. Adjusts price to capture consumer’s individual valuation of the public good

Question 16

Advantages of Lindahl pricing

Answer 16

1. Personalised prices equate individual valuations of the supply o public good to the cost of production of the good
2. Corrects the difference between price and social benefits

Question 17

Problems with Lindahl pricing

Answer 17

1. Preference revelation (want to lie about valuation)
2. Preference knowledge (individuals may not know their valuation)
3. Preference aggregation (how to weight preferences)

Question 18

Condition for equilibrium in Lindahl pricing

Answer 18

Each voter selects the same quantity at the announced set of prices