Chapter 4
Efficiency: Public Goods
and Externalities
Chapter outline
The rationale for government production of
goods and services.
1.Public Goods, Private Goods, and Goods with
Externalities
Nonrivalry
Nonexcludability
Free Riding and Public Goods
Some Qualifications
Free-riding and the Street Lights (A True Story)
Identifying Public Goods
Public Goods Versus Private Goods
Demand, Price, and Level of Output
Who Pays for Public Goods?
Local Public Goods, Club Goods, and Congestible
Goods
Externalities
Positive Externalities
Negative Externalities
Creative Solutions
Property Rights and the Coase Theorem
Tax Incentives and Vouchers
The Garbage Dilemma
Shifting the Demand Curve
Other Providers
1. Public Goods, Private Goods, and
Goods with Externalities
Public goods have two characteristics:
nonrivalry and nonexcludability
①nonrivalry
A good that is nonrival in consumption can
be consumed by any number of people
simultaneously ,without diminishing the
amount available to be consumed by others.
②nonexcludability
This term describes the inability to keep
people ,specifically nonpayers,from
consuming the good or service.
It is the problem of excluding nonpayers
rather than nonrivalry that is often the
determining factor in calling for public
production.
Exclusion technique:innovations in
technology and high fine.
2.Identifying Public Goods
All public goods can be classified according to
the degree of rivalry and excludability into four
classes.
low rivalry,low excludability goods are public
goods;
high rivalry,high excludability goods are private
goods;
low rivalry,high excludability goods are local
public goods or club goods;
high rivalry,low excludability goods are those that
create positive or negative externalities.
Figure 4-1 Classifying Goods and services by Rivalry and Excludability
①Public goods versus private goods
②Demand,price,and level of output
For public goods,demand is added vertically
rather than horizontally to determine the
optimum quantity.
Figure 4-2Market Demand and Optimal Output for Private Goods
Figure 4-3 Demand,Supply,and Equilibrium in the Market for a Public Good
③Who pays for public goods?
First of all,there is the challenge of
determining A’s and B’s valuations of the
public goods so that each can be charged the
appropriate price. for government the first
challenge is to measure or estimate difference
in demand from different individuals groups
within the population.
The second problem of getting to the optimal
quantity when it is not possible to exclude nonpayers
or free riders. The second challenge is to devise ways
of collecting revenue that approximate those Lindahl
price for different segments of the population.
When each person pays the price that reflects his
marginal benefit,he is being charged Lindahl price.
Some public goods lend themselves more easily
than others to such a strategy.
Optimality requires not only that total marginal
benefit be equal to marginal cost ,but also that the
marginal tax price paid by each citizen be equal to the
marginal benefit received.
④local public goods,club goods,and congestible
goods
A local public goods or a lub good is shared
by members of a group or community on the
basis of shared membership.free riding is
avoided because the good is excludable.
Congestible goods are a special case of local
public goods in which the marginal cost is very
low up to a capacity point at which the
marginal cost of additional users begins to
rises sharply.
Figure4- 4 Supply,Demand,and Price for a congestible Good
There are at least five reasons why the producer
should be charging a peak-period fee:
Ⅰ.The fee rations a scarce good among users.
Ⅱ.Revenue collected relative to the cost of collecting
it rises sharply.
Ⅲ.Additional users are imposing significant costs on
others in terms of congestion and delay.
Ⅳ.In the absence of fee,marginal benefit is equal to
the zero price.
Ⅴ.The price for congestion and noncongestion times
offers an incentive for other substitutions.
3.Externalities
Consumption (production) externalities occur when
a second person is affected by consumption
(production) of a good or service,either positively or
negatively.
①Positive externalities
Goods that create positive externalities or marginal
social benefits to someone other than the buyer will
be underproduced by the market in the absence of
intervention.
To determine the optimal quantity and
price,private demand and marginal social benefits are
added vertically.
Figure 4-5 Optimal Output for a Good with Positive Externalities
The fact that there are external benefits does
not necessarily mean underproduction will
occur.
How to fill in the ab gap?
Among the common methods of addressing
positive externalities are public production or
public subsidies of private production.
Public subsidies for private production are a
little more successful.
②negative externalities
Goods that create negative externalities or
marginal social costs to someone other than the
producer or consumer will be overproduced by the
market in absence of intervention.
To determined the optimal quantity and
price ,marginal social costs are added vertically to
the supply or marginal private cost curve.
Possible forms of intervention include
taxes,fees,fines,charges and regulations.
③creative solutions
Ⅰ.Assignment of property rights (the Coase theorem)
Coase theorem says that ,where small numbers of
participants are involved ,property rights can assigned
to one of the parties for a contested resource,and
subsequent negotiations will result in the socially
optimal use of the resource.
The coase theorem applies only to cases where
there are relatively few affected parties.Otherwise
there will be a potential for free riding.
Ⅱ.Tax incentives and vouchers
Ⅲ.Shifting the demand curve
Ⅳ.Marketable emission permits
Ⅴ.other providers
True-false questions
If false, change the statement to make it true.
1.A pure public good is both nonrival and
nonexcludable.
2.According to the Coase theorem, the outcome
of a dispute will be different depending on
which party is assigned the property rights.
3.Lindahl prices are intended to ensure that
everyone pays the same price for public
goods.
4.The property of nonrivalry refers to the
difficulty of keeping someone else from
consuming something I have paid for and
he/she has not.
5.If a good has positive externalities, in the
absence of intervention, private decisions
would result in consuming too much at too low
a price.
Answers:
1. T
2. F (It should be the same, barring any questions of
income distribution.)
3. F (Lindahl prices attempt to charge people
different prices that reflect their different marginal
benefits.)
F (The easiest correction is to change nonrivalry to
nonexcludability. Alternatively, nonrivalry should be
correctly defined as “my consumption does not
diminish the amount available to you” or similar
language.)
F (Correction is either to change positive to
negative or change too much to too little and too low
to too high.)