Chapter 3: Public Goods and Political Economy
Chapter 3
McGraw-Hill/Irwin
Public Goods
and Political Economy
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved
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Chapter 3: Public Goods and Political Economy
Introduction
The concept of a public good
Political economy
The behavior of the government
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Chapter 3: Public Goods and Political Economy
The Concept of a Public Good
Competitive markets generally work well, but there is a kind
of good that markets cannot be expected to handle well:
PUBLIC GOODS
A public good has 2 properties:
1. Non-rivalry
2. Non-excludability
A private good has 2 properties:
1. Rivalry
2. Excludability
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Chapter 3: Public Goods and Political Economy
Non-Excludability, Free-Riders
and Compulsory Taxation
Free Rider
Non-excludability
“I can’t be excluded from
using the public good.”
“So I don’t have to pay for
that public good.”
Solution?
Compulsory Taxation
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Chapter 3: Public Goods and Political Economy
Who Should Produce a Public Good?
After the government raises the money for a public good
through taxes, who should produce it?
Private Firms?
Government?
Both?
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Chapter 3: Public Goods and Political Economy
The Island Wall – assumptions
• 3 families on an island
• Merchant ships sell private goods to the families
• Pirates sometimes raid the island
Should a defensive wall (a public good) be built to
protect the island from pirates?
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Chapter 3: Public Goods and Political Economy
The Island Wall – graph
Figure 3.1
• Individually, none of the
$800 -
families would build a wall
on their own:
$700 -
MB < MC
$900 -
$600 -
MC
$500 $400 -
• The MB curves
$300 -
are in a ratio of:
$200 $100 -
I
2
I
4
I
6
I
8
I
10
I
12
MBH
3:2:1
MBM
MBL
I
14 Wall Thickness (ft)
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Chapter 3: Public Goods and Political Economy
The Island Wall – graph
$900 -
Summing their marginal
benefits, this public good
should be built.
$800 -
 MB > MC
$700 -
But how thick?
Figure 3.1
$600 -
MC
$500 -
 MB
$400 -
$300 $200 $100 -
I
2
I
4
I
6
I
8
I
10
I
12
10 feet thick is the
socially optimal or
efficient thickness
of the wall!!
MBH
MBM
MBL
I
14 Wall Thickness (ft)
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Chapter 3: Public Goods and Political Economy
Efficiency
At the efficient,
socially optimal quantity of a public good,
MB = MC
At the efficient,
socially optimal quantity of a private good,
MB = MC
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Chapter 3: Public Goods and Political Economy
Political Economy
How does a community collectively make decisions
concerning a public good?
How do you choose the
socially optimal quantity?
Each family, individually,
would not build the wall,
but if they get together
and collectively decide
what to do, they would
build the wall.
So… how much will
each family be willing to
pay towards the
construction of the wall?
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Chapter 3: Public Goods and Political Economy
Cost-Share and Efficiency
Unanimous choice of the efficient quantity of the
public good depends upon:
• Cooperation
• Each family being honest about their MB curves
• Each family agreeing to cost-share in the same
ratio as their MBs
Cost-share is the price each family must
pay per unit of the public good
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Chapter 3: Public Goods and Political Economy
A Unanimity Rule
Unanimity rule – all families agree in advance to build a
certain thickness of a wall if all families support it.
Pros
All families enjoy a net
benefit from the public
good, and cost-share
ratios will be equal to
their MB ratios
Cons
A family may be dishonest
about their MB and hold
out for a lower cost-share,
preventing the efficient
outcome
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Chapter 3: Public Goods and Political Economy
Majority Rule Voting and the Median Voter
Majority rule voting – if two of the three families vote for a
certain thickness of a wall, then that thickness will be built.
Outcome
With majority voting, when cost-shares have
been assigned, the outcome will be what the
median voter prefers, but it may not be the
efficient outcome
Median voter – the family with the middle ranking or
preference of wall thickness
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Chapter 3: Public Goods and Political Economy
Majority Rule Voting:
Single and Double-Peaked Preferences
Table 3.1
Choice
H
M
L
D
thick
int.
thin
thin
Second
int.
thin
int.
thick
Third
thin
thick
thick
int.
First
H, M, and L vote between:
H, M, and D vote between:
• Thick and Intermediate
• Thick and Intermediate
• Intermediate and Thin
• Thick and Thin
Outcome: Intermediate
Outcome: Thin
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Chapter 3: Public Goods and Political Economy
Majority Rule Voting:
Single and Double-Peaked Preferences
Figure 3.2
Choice
Outcome
H
1st
2nd
D
3rd
M, L
Thin
Intermediate
Thick
Pair-wise voting can
lead to cycling with no
clear, stable outcome.
Wall thickness (ft)
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Chapter 3: Public Goods and Political Economy
Government and Optimal Taxation
When there are many families,
often a government is established.
How do you tax to provide
the efficient quantity of
public goods?
Regressive
Taxation
Proportional
Taxation
Progressive
Taxation
What about practical obstacles?
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Chapter 3: Public Goods and Political Economy
The Behavior of Government
Decisions about public goods are made by a legislature,
not by citizens directly.
Election between candidates DOVE and HAWK
Dovish Voters
0%
10%
Hawkish Voters
20%
30%
40%
Figure 3.3
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Chapter 3: Public Goods and Political Economy
Lobbying, Special Interests, Campaigns,
Bureaucracies, and Corruption
• Logrolling
• Lobbying
• Special interests
• Campaigns
• Bureaucracies
Potential
Issue
The interaction between special interests and
government bureaucracies creates prospects
for corruption.
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Chapter 3: Public Goods and Political Economy
Public Choice, Government Failure, and
Constitutions
Public choice school of economists believes that legislators,
executives, and bureaucrats are biased towards expanding
the government beyond what is best for the public and there
may be a…
… government failure.
Public choice economists argue that these
legislators need to be restrained by a...
... constitution
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Chapter 3: Public Goods and Political Economy
Summary
The concept of a public good
Political economy
The behavior of the government
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Chapter 3: Public Goods and Political Economy
Preview of Chapter 4:
Cost-Benefit Analysis
Cost-benefit analysis
Building a factory
Benefits from building a highway
Benefits from improving the safety of a highway
Mistakes to avoid
Reducing global warming
Paying for a costly medical treatment
Intervening militarily
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