NPTEL-Economics-Public Economics
Module 4
Lecture 17
Topics
4.13 Private vs. Public Good: Optimality Conditions
4.14 When is Private Provision Likely to Overcome the Free
Rider Problem?
4.15 Can Private Providers Overcome the Free Rider
Problem?
4.16 When is Private Provision Likely to Overcome the Free
Rider Problem?
4.17 Some Individuals Care More than Others
4.18 Altruism
4.19 Warm Glow
4.13 PRIVATE VS. PUBLIC GOOD: OPTIMALITY
CONDITIONS
First Best if G is Private good:
Decentralized market equilibrium will implement such an allocation
First Best if G is Public good:
Decentralized private provision is suboptimal
– Market outcome is inefficient; underprovision of G
1
Indian Institute Of Technology, Kanpur
NPTEL-Economics-Public Economics
4.14 WHEN IS PRIVATE PROVISION LIKELY TO
OVERCOME THE FREE RIDER PROBLEM?
While the free-rider problem clearly exists, there are also examples where the
private market is able to overcome this problem to some extent.
Examples of private provision of a public good
– Privately financed highways.
But the private market may still fall short of the socially optimal amount.
4.15 CAN PRIVATE PROVIDERS OVERCOME THE
FREE RIDER PROBLEM?
Gurgaon was widely regarded as an economic wasteland. In 1979, the state of
Haryana created Gurgaon by dividing a longstanding political district on the
outskirts of New Delhi. One half went to Faridabad, which had an active
municipal government, direct rail access to the capital, fertile farmland and a
strong industrial base. The other half, Gurgaon, had rocky soil, no local
government, no railway link and almost no industrial base.
Gurgaon’s disadvantages turned out to be advantages, none more important,
initially, than the absence of a district wide government, which meant less red
tape capable of choking development.
Gurgaon has no publicly provided “functioning citywide sewer or drainage
system; reliable electricity or water; public sidewalks, adequate parking, decent
roads or any citywide system of public transportation.”
Not only are services such as roads and utilities poor, the private oases don’t
internalize all the externalities so there are problems with common resources such
as the water table. It would also be more efficient to have centralized sewage and
electricity.
BUSINESS IMPROVEMENT DISTRICTS
BID in New York
– The quality of city streets is a public good.
– During the 1980s, New York City had high crime. The city had lost all
hopes of cleaning up Times Square.
2
Indian Institute Of Technology, Kanpur
NPTEL-Economics-Public Economics
– In 1992, local businessmen started a BID–a legal entity to provide security
and sanitation, with fees collected from local businesses.
New York law makes participation of businesses compulsory if BID organizers
can get 60% of local businesses to join, allowing the organizers to overcome the
free-rider problem.
– The BID was a success in New York City.
BID in Massachusetts
– Law allows businesses to “opt-out” of a BID within 30 days of the BID
approval by the local government.
– This deters formation of BIDs in the first place, because there are fixed
costs of doing so.
– As a consequence, only 2 BIDs have been formed in Massachusetts.
4.16 WHEN IS PRIVATE PROVISION LIKELY TO
OVERCOME THE FREE RIDER PROBLEM?
Under what circumstances are private market forces likely to solve the free rider
problem?
– Intense preferences.
– Altruism.
– Utility from one’s own contribution to the public good.
4.17 SOME INDIVIDUALS CARE MORE THAN OTHERS
When some individuals have especially high demand for a public good, private
provision may emerge (but not necessarily provide efficiently).
The key intuition is that the decision to provide a public good is a function of the
enjoyment that the individual gets from the total amount of the public good, net of
cost.
– If a person gets a lot of enjoyment, or has a lot of money, he will choose to
purchase more of the public good even though it benefits others.
Olson and Zeckhauser (1966) studied the financing of NATO (North Atlantic
Treaty Organization), which was a voluntary organization at the time.
3
Indian Institute Of Technology, Kanpur
NPTEL-Economics-Public Economics
– Although countries had an incentive to free-ride on the contributions of
others, the largest nations (such as the United States) did contribute.
– Higher incomes or stronger tastes can mitigate the free rider problem to
some extent, but are unlikely to solve it completely. Thus, underprovision
is still likely to occur.
4.18 ALTRUISM
Another reason is that there is evidence that many individuals are altruistic,
caring about the outcomes of others as well as themselves.
Once again consider the experiment by Marwell and Ames 1981; a wide majority
did contribute to the group fund.
Some real-world evidence is consistent with altruism in private support of public
goods.
– Brunner (1998) found that the number of public radio listeners who
contribute decreases only modestly as the total number of listeners
increases.
4.19 WARM GLOW
A final reason is that that individuals may provide for a public good is due to
warm glow.
– The warm glow model is a model of public good provision in which
individuals care about both the total amount of the public good and their
particular contributions as well.
For example, they may get some psychological benefit from knowing they helped
a worthy cause.
In this case, the public good becomes more like a private good, though it does not
fully solve the underprovision problems.
4
Indian Institute Of Technology, Kanpur