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Market Failure and the Role of Government: Public Goods AP MICROECONOMICS MR. BORDELON

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Characteristics of Goods

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Excludable. Suppliers of the good can prevent people who dont pay from consuming it. Rival in consumption. Same unit of the good can not be consumed by more than one person at a time. Example. A car dealership sells a car to Tom at a price of $20,000. Tom gets the car because he is willing and able to pay that price. The seller does not sell a car to Becky because Becky considers that price to be out of her budget. The car is excludable. This means that the seller does not have to provide a car to Becky or the rest of the people in town who are unwilling and unable to pay the going price. Once Tom has purchased the car, the car is his. In other words, he has consumed this unit of that good and thus prevents Huck from buying it off of the car lot. Of course Tom could give Huck a ride, or sell the used car to Huck, but once he sells it to Huck it now belongs to Huck. Tom cannot sell it to Huck and also sell it to Becky. Private Goods

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Non-excludable. Anyone can consume it. Non-rival in consumption. Good can be consumed by more than one person at the same time. Example. Cities have fire departments that protect all homes in the city and cant exclude anyone on the basis of payment. And more than one person can consume the fire protection at the same time. If a fire breaks out at Margarets house, the fire department rushes to put it out. This prevents the fire from spreading to Melanies store, so both people are consuming the same unit of fire protection. Public Goods

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Excludable. Non-rival in consumption. Example. A college economics lecture is excludable because only students who have paid tuition can enroll in the course and attend the lecture. However it is non-rival because many people can consume the same unit of the good at the same time. Other examples are pay-per-view movies or sporting events. Artificially Scarce Goods

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Non-excludable. Non-rival in consumption. Example. The stock of salmon in the Pacific Ocean has historically been a common resource. If a person had a boat, they could harvest salmon from the ocean, or even scoop the fish from the bank of a river as the salmon headed upstream. This made the salmon non-excludable. However once a salmon is caught, it cannot be caught by a second person, which makes it rival. Common Resources

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Markets are efficient except in the case of market power, externalities or other instances of market failure. Markets can only supply goods and services efficiently if the goods are excludable and rival in consumptionprivate goods. Free rider. Goods that are non-excludable suffer from this. Individuals have no incentive to pay for their own consumption and instead will take a free ride on anyone who does pay. Markets Supply Only Private Goods Efficiently

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With public goods, the non-exclusive nature of the goods and the free-rider problem will prevent an efficient quantity from being produced in a market. So much so that zero units may be produced (or not, as it were). Markets Supply Only Private Goods Efficiently

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Artificially scarce goods face a similar problem with respect to free- riders. Example. Pay-per-view of $10 per game. Because this is greater than zero, fewer consumers will purchase the game and the number of units consumed will be less than the efficient quantity. The efficient quantity would be zero assuming this was not pay-per-view. More than one person can consume this good despite the $10 excludable price tag. Markets Supply Only Private Goods Efficiently

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Private goods dont have this problem. Firms can charge a price and thus have an incentive to produce them. Goods are rival, consumers have an incentive to pay a positive price for them. If firms have an incentive to offer a good at a price above zero and there are enough consumers willing to pay that price a market will emerge for the good. Markets Supply Only Private Goods Efficiently

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There are really only a small number of ways in which a good is supplied: by private firms or by the government. Private firms wont supply public goods, so that leaves voluntary contributions or the government. Research for disease prevention is a public good that requires a lot of money to provide. Some of those funds are donated by citizens and corporations, but the government must provide the rest. Example. National defense is a public good that could not survive on voluntary donations so the government provides all of it. Government provides public goods by collecting taxes from the population. Providing Public Goods

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Streetlights along a city street are a public good. How many lights should be provided in the city? Suppose that Bob and Sandy are the only residents and that they truthfully tell the government how much they would be willing to pay for each streetlight. This willingness to pay (WTP) is also each residents marginal private benefit (MPB) to having the next light installed. What is the first streetlight worth to this town? Bob: $10 Sandy: $18 Total marginal private benefit (MPB): $28 How Much of the Public Good Should be Provided?

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StreetlightsBobs MPBSandys MPBMSB = MPB B + MPB A 1$10$18$28 281523 361218 44913 5268 How Much of the Public Good Should be Provided? How many should be installed? The answer lies with the MSC of the lights. If each light cost the town $12, the first four will be installed because MSB > MSC, but the fifth would not because it is inefficient. Even assuming Bob or Sandy was a free rider, the results would be the same because it was a public good.

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Lets look it from a graph perspective. This curve represents Teds MPB. As you can see, the benefit decreases with each additional street cleaning. Notice that the MPB decreases with each additional street cleaning. How Much of the Public Good Should be Provided?

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Alice has a similar MPB curve, declining according to her own personal benefit. How Much of the Public Good Should be Provided?

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Putting both Ted and Alice together, we can create the marginal social benefit curve (total benefit to both). Here, we have a MSC of $6, meaning it costs $6 per street cleaning. How much would we produce? How Much of the Public Good Should be Provided?

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We would produce 5, where the MSB > MSC. Once we go past 5, it actually costs society more to produce, effectively a loss of $4 per street cleaning when producing 6. How Much of the Public Good Should be Provided?

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AP Examples: Fish, oceans, clean air, clean water, biodiversity. The biggest problem with common resources is overuse. Because they are non-excludable and rival in consumption, competitors will overuse the resource. Want a good website to illustrate this: http://www.bunnygame.orghttp://www.bunnygame.org Common Resources

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We live in Florida and we get most of our fresh water from the aquifer. If I drill a well for my own personal use, its non-excludableothers can consume this water. For every gallon I use, however, its one that someone else can not useits rival. My consumption of water drops the aquifer, making it more costly for others to get their water. My MPC of the next gallon of water is lower than the MSC. The socially optimal quantity of water is less than the market quantity of water. This tells us that a common resource will be overused. If rainfall is insufficient to recharge the aquifer, we will exhaust it. Common Resources

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Graphing it out, we see this problem of overuse. MSC will eventually cross the supply curve, and exhaust the resource. Anytime the Q OPT of a common resource is less than the Q MKT, then the common resource will be over used. Common Resources

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These solutions should look familiar (think negative externalities): Tax or otherwise regulate the use of the common resource. Create a system of tradable licenses for the right to use the common resource. Make the common resource excludable and assign property rights to some individuals. Efficient Use and Maintenance of a Common Resource

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Pay-per-view movies are artificially scarce because they are excludable but non-rival. The cable company can exclude me from watching the movie if you dont pay the price, and if you watch the movie it doesnt deny another household from also watching the movie. The marginal cost of providing the movie to one more household is zero. The efficient quantity would be the quantity where the demand curve intersects the horizontal axis and the price would be zero. Of course there is no way the firm can profit if the price is zero, so the firm sets a price of maybe $5 and excludes some of the potential customers. If the price is $5, fewer movies will be ordered than the efficient number. This is why this good is called artificially scarce. Artificially Scarce Goods