Week 5 Flashcards
Public goods - Introduction
In the perfectly competitive market, property rights are assumed to be perfectly defined and enforced. This implies goods and services are excludable and rivalrous in consumption.
In reality, many goods and services are associated with property rights problems:
No-excludable
Non-rivarlous
Non-excludable
Once produced, no one can be prevented from using the good
Non-rivalrous
One persons use of the good does not diminish other peoples use
Rivalrous excludable goods
Private goods
Congested Toll road
Rivalrous non-excludable goods
Common resources
Congested non-toll road
non-Rivalrous non-excludable goods
Public goods
No toll non congested road
non-Rivalrous excludable goods
Club goods
Non-congested toll road
People seldom break a line while waiting for checkout in a supermarket. This is an example of a ______ to solve an externality
Social enforcement mechanism
Do Private goods and club goods present market failure
Private goods and club goods do not present market failure – they have prices attached to them.
Do Public goods and common resources present market failure
Public goods and common resources present market failure – externalities arise because something of value has no price attached:
If a person were to provide a public good, for e.g. national defence, others would be better off and yet they are not charged for this benefit;
If a person uses a common resources, for e.g. fish in the ocean, others would be worse off and yet they are not compensated for this loss.
Public goods and common resources present market failure – externalities arise because something of value has no price attached
What happens due to these externalities
Due to these externalities, private decisions about production and consumption can lead to inefficient outcomes (market failure).
Government intervention (public solutions) can potentially correct inefficiency and raise economic well-being.
Public goods
Public goods are goods that are non-excludable and non-rivalrous
Some examples: fireworks displays, lighthouses, national defence, basic research (knowledge), free-to-air TV and radio.
Due to these two features, people have an incentive to be free riders
Free rider
A person who receives the benefit of a good but avoids paying for it
The free rider problem
The free rider problem
The existence of free riders lead to the under-provision of public goods in the market (the free rider problem).
The market fails to provide the efficient outcome because those who gain a benefit from consuming the public good do not compensate the supplier for the production costs. Hence, the supplier has no incentive to provide the good.
The government can remedy this problem by providing or subsidising the public good and paying for it with tax revenue, to make everyone better off. This is a public solution.
Public goods public solutions
National defence
Basic research (knowledge)
Fighting poverty
National defence
one of the most expensive public goods.
Solution: People may disagree on the appropriate levels, but most will agree that some government spending on defence is necessary.
Basic research (knowledge)
– general knowledge is a public good; profit seeking firms have incentive to free ride on the knowledge created by others.
Solution: Government subsidises the basic research carried out by universities and other research organisations (this is a corrective subsidy on the positive externality generated).
Fighting poverty
everyone prefers living in a society without poverty, but fighting poverty is not a ‘good’ that private actions will adequately provide.
Solution: Many government programs are aimed at helping the poor, for e.g. unemployment benefits, old-age pensions, disability support, funded by tax revenue.
Cost-benefit analysis
A study that compares the costs and benefits to society of providing a public good.
Before providing a public good, government conducts a cost-benefit analysis to determine whether it is efficient to do so.
Public goods private solutions
Free-to-air TV and radio - non-excludable and non-rivalrous, yet provided by private firms as for-profit business. For e.g. Freeview.
Public goods private solutions
Free to air TV
How is revenue generated, when consumers enjoy for free?
Solution: broadcasters sells a complementary, private good i.e. advertising. Sells airtime to advertisers.
Advertisers are willing to pay more if their ads are shown during a program that has many viewers. This gives broadcasters incentive to show programs that viewers want to watch. Hence, viewer demand drives what is shown.
Other examples of the private provision of public goods:
search engines e.g. Google and Bing; and video sharing sites e.g. YouTube and Vimeo. These are funded by the revenue from the ads displayed on the webpages.
Common resources
goods that are non excludable but rivalrous
Some examples: clean air and climate change, oil deposits, congested non-toll roads, fish, whales and other wildlife
The tragedy of the commons refers to the overgrazing of communal land surrounding medieval English villages.
The tragedy of the commons
A parable that illustrates why common resources get used more than is desirable from the standpoint of society as a whole
The tragedy of the commons explained
Each family in the village has the right to graze sheep on the commons. When one family’s flock grazes on the common land, it reduces the quality of the land available for other families. Because people neglect this negative externality when deciding how many sheep to own, the result is an excessive number of sheep. Overgrazing eventually damages the land’s ability to replenish itself, destroying the common resource for all families in the village.
Common resources private solutions
Overgrazing on the commons
Clean air and climate change
Oil deposits
Overgrazing on the commons
the community can prevent the tragedy in a number of ways.
Solution: regulate the number of sheep in each family’s flock or divide up the land among the families.
Clean air and climate change
greenhouse gasses emitted in one country spread around the world contributing to climate change in every country. When a government in one country regulates emissions, it considers only its own environment, not the effects on other countries.
Solution: the Coase Theorem suggests that nations can enter into a treaty (e.g. the Kyoto Protocol) which commits them to reduce their own emissions. The treaty behaves like contract, internalising the externality.
Oil deposits
a large oil field lies under many properties with different owners. Any of the owners can extract the oil, but when one owner extracts oil, less is available for the others. Because each owner who drills a well imposes a negative externality on the other owners, the benefit to society of drilling a well is less than the benefit to the owner who drills it. If owners of the properties decide individually how many oil wells to drill, they will drill too many.
Solution: some type of joint action or agreement among the owners is necessary to solve the problem and ensure that oil is extracted at lowest cost.
