Private vs Public Goods
What difference does it make?
Would you like government to provide you
free college?
What might you have to give up to get it?
Three areas of concentration
1.
Explain how market failures, such as externalities, might justify economic functions
of government
2. Distinguish between private and public goods and explain the nature of the free-rider
problem
3. Describe the political functions of government that entail its involvement in the
economy
What is Market Failure?
• When the market produces more or less than
the ideal optimal good or service. OR the
wrong mix of input is given for output…..
• Brings about externalities and public goods.
When the market fails… it is a double
edge sword
Market Fails if not optimal mix.
* Optimal Mix of Output……
“Most desirable combination of output attainable
with existing resources, technology and social
values.”
Market Failure
*“An imperfection in the market mechanism that
prevents optimal outcomes.”
Problem in economy- Hydrocarbons in the
air.
Problem in economy- Hydrocarbons in the air.
Cause- SUV’s, Trucks (poor ignition system, etc.)
Solution – Do not manufacture SUVs, Trucks.
Regulation prevents- government permits only
electric cars and small cars.
Trucks still on road –
Reallocation of resources to government’s choice?
What about just taxing SUVs more rather than
not permitting production?
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Price directs resources
Business is operating to make a profit
Why would Dell want to build a park?
Why would Wal-Mart want to pay high wage?
Why would Texas not provide health
insurance for poor?
In real words?
Wrong mix of output
Not enough public parks…
Not enough care for environment…
Not enough welfare…
Too much separation between top 10%
income earners and median income
earners…
Not adequate security within our borders….
Too many immigrants….
How do you know if optimal mix is
met?
Optimal mix of ANY GOOD or SERVICE =
MB = MC
(Marginal benefit = Marginal Cost)
If the cost exceeds the benefit… the failure
occurs. If benefit exceeds the cost, then
market is functioning according to other
factors (price, demand, etc.)
Plano City Council issues “no
smoking” in restaurants, bars, or
outside bars on patios.
What is the marginal private cost to Sports
Bar?
What is the external cost to Plano?
What is the social cost? C > B?
The smoke in Sports Bar= externality
What is an externality?
Result of an economic activity that harms a
third person. (breathing smoke in restaurant)
Negative externality (also referred to as
spillover)
Can also have a positive externality.
Specific Example:
Assume no government regulation exists.
Steel producing plant moves into the neighborhood.
Production of steel emits dirt, smut, unhealthy air
throughout the neighborhood.
This is a negative externality… the spillover is the
dirty air borne by the citizens.
Who pays for this cost? Citizens- company making a
profit on steel.
Socially Optimal Amount (Output)
Sometimes, the socially optimal amount is
referred to as the efficient amount.
Correcting for Externalities (cont'd)
• Market failure: an example
– Market failure occurs
• Steel mill does not pay for the clean air
• Costs of production have “spilled over” to the residents
(third parties)
• Lower production cost
– ***More steel is produced than would otherwise be the case
Market failure = (forces of S & D not leading
us to BEST point on ppc… Who decides
what is defined as BEST?
Enter…. Government intervention!
Did you hear the words tax and subsidy?
Will they perform magic?
Correcting for Externalities
• Externalities
– Occur when the consequences of an economic
activity spill over to affect third parties
• Third Parties
– Parties who are not directly involved in a given
activity or transaction
• Property Rights
– Rights of an owner to use and exchange property
Examples of spillovers
Throwing trash in someone’s back yard
Burning ties in the alley
Playing your stereo loudly at 3:00 a.m.
Businesses dumping wastes, sludge into rivers
People trashing the beach or highway.
Electric Companies burning phosphorous fuels
Spillover Examples that perpetrate on others
Calling police when loud party of teenagers
next door (actions of teens imposing
unwanted cost on neighbor)
Living in downstairs apartment.. Having
upstairs neighbors doing Tai Bo when they
get off work at 4:00 a.m.
Calling the city when a neighbor doesn’t
keep his yard mowed on regular basis.
Externalities can be positive or negative
Homeowners keep lawns immaculate
(benefits the neighborhood)
Scientific study for polio vaccine (others
benefit beyond scientists’ recognition)
 Education……. How would this be a benefit?
How can spillovers be corrected?
Most obvious way is Legislation.
1. To prohibit
2. To heavily tax the specific product and
manufacturer. Tax would be derived to allow for
off-setting the clean-up cost. (Super Fund is
example)
3. ***Tax incentives… if reduction of pollution and
compliance adhered to, taxes reduced.
There are two main types of economic instruments used in environmental
policy, both of which aim to provide an incentive to use resources sustainably:
• Price-based measures use charges, taxes and
subsidies to persuade polluters to reduce their
discharges.
• Rights-based measures "create rights to use
environmental resources, or to pollute the
environment, up to a pre-determined limit,
and allowing these rights to be traded"
Two concepts to remember
• Public goods… can be equally consumed by
all… no restrictions
Skateboarding in the park… Terrorists… can also
go to the park… Illegal immigrants can go to
school…
• Private goods… consumption by one person
excludes consumption by another..
( my doughnut… my car… etc)
The Public Sector:Government’s role.
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What is Public Sector?
When markets fail? (Housing!)
Should government step in?
Can people “ride free” in public sector?
Let’s Talk Social Costs.
• Social Cost = private cost + externality (if any)