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7
7.1 Optimal Provision of Public Goods
7.2 Private Provision of Public Goods
7.3 Public Provision of Public Goods
7.4 Conclusion
Public Goods
7
Public Goods: Trash Collection in Dhaka, Bangladesh
Why don’t people pay to have their neighbor’s trash collected
No one wants to pay, but everyone wants someone else to pay.
Private trash collection, financed by a voluntary fee paid by neighborhood residents, faces the classic free rider problem.
Goods that suffer from this free rider problem are known in economics as public goods.
7.1
Pure public goods: Goods that are perfectly non-rival in consumption and are non-excludable.
Non-rival in consumption: One individual’s consumption of a good does not affect another’s opportunity to consume the good.
Non-excludable: Individuals cannot deny each other the opportunity to consume a good.
Impure public goods: Goods that satisfy the two public good conditions (non-rival in consumption and non-excludable) to some extent, but not fully.
Public Goods: A taxonomy
7.1
Defining Pure and Impure Public Goods
Is the good rival in consumption Is the good excludable Yes No
Yes Private good (ice cream) Impure public good
(cable TV)
No Impure public good (crowded sidewalk) Public good
(defense)
7.1
How much of the public good should society provide
Markets will not provide the correct amount.
To answer this question, start by reconsidering the market for a private good like ice cream cones.
Ben and Jerry have different tastes for ice cream (ic), relative to the other good (c). How does the market aggregate their preferences
Optimal Provision of Public Goods
7.1
Ben and Jerry demand different quantities of the good at each price.
The optimality condition for the consumption of private goods is written as:
Equilibrium on the supply side requires . Therefore in equilibrium, .
marginal cost of production, equals marginal benefit, or .
Horizontal Summation in Private Goods Market
Price
of ice cream cone
Price
of ice cream cone
Price
of ice cream cone
Quantity of cones
Quantity of cones
Quantity of cones
$2
$2
$2
2
1
3
0
0
0
DB
DJ
E
S = SMC
DB&J = SMB
To find the social demand curve, add quantity at each price and sum horizontally.
Horizontal Summation in Private Goods Market
7.1
Ben’s Marginal
Benefit
Jerry’s Marginal
Benefit
Market
7.1
With public goods, such as missiles (m), Ben’s consumption doesn’t reduce Jerry’s.
Therefore the social-efficiency-maximizing quantity solves
Social efficiency is maximized when the marginal cost is set equal to the sum of the MRSs, rather than being set equal to each individual’s MRS.
Optimal Provision of Public Goods
Price of missiles
Price of
missiles
Price of missiles
Quantity of missiles
Quantity of missiles
Quantity of missiles
DB
DJ
S = SMC
DB&J = SMB
$2
1
0
0
0
$4
$6
2
3
1
5
1
5
1
5
Vertical Summation in Public Goods Market
7.1
Ben’s marginal benefit
Jerry’s marginal benefit
Social marginal benefit and cost
7.2
The market does not produce the efficient amount of public goods because of the free rider problem.
Free rider problem: When an investment has a personal cost but a common benefit, individuals will underinvest.
Since Ben’s consumption of missiles also benefits Jerry, Jerry may not want to pay (or vice versa).
This results in the private market producing an inefficiently low quantity of the good.
Private Provision of Public Goods: Private-Sector Underprovision
7.2
The free rider problem is one of the most powerful concepts in all of economics.
Radio and television programming:
WNYC has an estimated listening audience of more than 1 million people each week, but only 7.5% of their listeners support the station.
The United Kingdom uses a nonmarket solution: The BBC charges an annual licensing fee to anyone who owns and operates a TV!
APPLICATION: The Free Rider Problem in Practice
APPLICATION: The Free Rider Problem in Practice
7.2
Online information sharing:
Over 500 million unique visitors consult Wikipedia.
The content is exclusively written by volunteers.
About 6% of readers have ever made an edit.
About 3% of non-editing readers donated to the nonprofit so others can make edits.
7.2
The free rider problem does not lead to a complete absence of private provision of public goods.
When private suppliers are given the ability to overcome the problem of non-excludability, they can produce the efficient quantity of the good.
The private sector can in some cases combat the free rider problem to provide public goods by charging user fees that are proportional to their valuation of the public good.
Can Private Providers Overcome the Free Rider Problem
7.2
Clean, safe sidewalks are public goods.
Cities attempt to provide them through street repair and police work, financed with tax revenue.
But New York City’s Times Square in the 1980s was a failure:
“Dirty, dangerous, decrepit, and increasingly derelict”
In 1992, a group of private firms formed a “Business Improvement District” to improve the area themselves.
APPLICATION: Business Improvement Districts
7.2
How did this BID work
A (BID) is a legal entity that privately provides local services and funds these services with fees charged to local businesses.
How do BIDs overcome free rider problem
NYC law allows BIDs to levy fees on nonpaying members, as long as 60% of members contribute.
In the Times Square case, 84% of local businesses agreed to pay fees to fund the BID’s services.
APPLICATION: Business Improvement Districts
7.2
Resounding success:
Crime has dropped significantly.
The area is cleaner and more attractive.
Business and tourism are booming.
Success of BIDs depends on the legal underpinnings: Can members charge fees to encourage payment
The BID entity overcame the public goods problem by overcoming the non-excludable assumption. They received government permission to (potentially) charge, via a tax, all consumers.
APPLICATION: Business Improvement Districts
7.2
Markets can (mostly) overcome the free rider problem when some individuals care more than others.
Suppose Ben cares much more about fireworks than Jerry.
Then, Ben will want to buy a lot of fireworks for himself ).
And the efficiency loss is not too great (.
When Is Private Provision Likely to Overcome
the Free Rider Problem
7.2
Private markets provide public goods when people are altruistic.
Altruistic: When individuals value the benefits and costs to others in making their consumption choices.
Many laboratory experiments provide evidence for altruism and show that people contribute to public goods.
Social capital: The value of altruistic and communal behavior in society.
The quantity of social capital depends on how much people of the same community affected by the public good can “trust” each other and are therefore willing to chance their personal investment of time and effort into paying for the public good without any formal guarantee of reciprocity from other community members.
Altruism and Social Capital
7.2
People might simply feel good about contributing to public goods or charity.
Warm glow model: A model of the public goods provision in which individuals care about both the total amount of the public good and their particular contributions as well.
Different from altruism because people don’t care about just the amount of the public good.
Warm Glow
7.3
Despite private provision, there is a role for government provision of public goods.
Under private provision, not everyone contributes to the good, even though everyone benefits.
Government provision potentially solves the problem of noncontributors.
Nonetheless, there are several challenges to government provision.
Public Provision of Public Goods
7.3
Crowd-out: As the government provides more of a public good, the private sector will provide less.
Warm glow: If people care about contributions per se, they may continue to contribute even when the government contributes.
Evidence on crowd-out: Mixed.
No evidence for full crowd-out
No consensus on the size of this important individual response to government intervention
Private Responses to Public Provision:
The Problem of Crowd-Out
7.3
The evidence on crowd-out is mixed.
Kingma (1989) looked at how contributions varied as local governments contributed different amounts to public radio.
The study found that $1 increase in government funding for public radio, private contributions fell by 13.5 .
Bias: Areas with high government contribution could be high income, or have a high taste for radio.
EVIDENCE: Measuring Crowd-Out
7.3
Laboratory evidence seems more convincing.
In another study, individuals tokens to a public good.
A 2-token tax on every player was then contributed to the public good.
Without warm glow effects, players should have reduced their contributions by 2 tokens.
However, each player cut his or her contributions by only 1.43 tokens.
Unclear how well this result generalizes outside of the lab, however.
EVIDENCE: Measuring Crowd-Out
7.3
One extreme is provision entirely by the public sector.
The other extreme is subsidized or mandated private provision, with the government providing incentives.
Contracting out: An approach through which the government retains responsibility for providing a good or service but hires private-sector firms to actually provide the good or service.
The Right Mix of Public and Private
7.3
Two problems with contracting out:
The private sector’s incentives may not align with public goals, leading to lower public costs but worse outcomes along other dimensions that policymakers may care about.
Bidding in contracting out is often far from competitive.
The Right Mix of Public and Private
7.3
Optimal public good provision requires knowing the MRS for each person. How to measure this
Consider the case of a highway. Cost includes wages and materials.
What if, without this highway project, half of the workers on the project would be unemployed
How can the government take into account that it is not only paying wages but also providing a new job opportunity for these workers
Measuring the Costs and Benefits of Public Goods
7.3
The benefits of highway construction are also difficult to measure.
What is the value of the time saved for commuters due to reduced traffic jams
And what is the value to society of the reduced number of deaths if the highway is improved
Measuring the Costs and Benefits of Public Goods
7.3
Three challenges in measuring preferences for public goods.
Preference revelation: People may not want to reveal their true valuation because the government might charge them more for the good if they say that they value it highly.
Preference knowledge: People may not know what their valuation is.
Preference aggregation: How can the government combine the preferences of millions of citizens
How Can We Measure Preferences for Public Good
7.4
Conclusion
A major function of governments at all levels is the provision of public goods.
Sometimes the private sector can provide public goods but usually not the optimal amount.
Government intervention can potentially increase efficiency.
Success of intervention depends on the:
Ability of government to measure costs and benefits.
Ability to implement optimal plan.

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