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Public Goods
SO FAR
We have seen that the role of government in promoting efficiency is to intervene in the pricing mechanism of goods that create externalities. Now we will investigate a class of goods where it is usually more efficient for the government to supply instead of the private sector.
Public Goods:=(Law and Order, defence, refuse collection, roads, education, public health,)
Outline
1. 2. 3. 4. Definition and Description Free-riding Optimal Provision: Problems of Preference Revelation
Definition
A Public Good has 2 properties: (1) If it has been provided to one consumer it is difficult/impossible to stop another from enjoying it too.
Non-Excludable
(2) The amount of the good I enjoy has no affect on the amount you enjoy.
Non-rival
Example: TV Signals
NON-RIVAL RIVAL
NON-EXCLUDABLE
EXCLUDABLE
CONSEQUENCES
Non-excludable: Very difficult for the private sector to provide it and make a profit. (Basic Research, Information, R&D) Non-rivalry: Do not want to exclude people as it is inefficient (The marginal cost of them getting the good is zero and they get positive benefit.)
I Dont Pay
(-1,-1)
(-1,3)
I Dont Pay
(3,-1)
(0,0)
(-1,-1)
(-1,3)
I Dont Pay
(3,-1)
(0,0)
In the USA people pay voluntary subscriptions for the public broadcasting service less than 10% do so. (In the UK it is mandatory to pay the TV licence fee.)
The town of Cambridge distributed 350 bikes around the town for people to use free of charge. (You had to return the bike to a special stand after using it.) Within 4 days they had all gone.
User Fees for Excludable Public Goods and for Publicly Provided Private Goods
Some public goods are excludable roads, bridges etc. Some goods (education, water) have large cost of supplying additional individuals are often publicly provided.
Price/Fee
Demand/Users Value
# of users
User Fees for Excludable Public Goods and for Publicly Provided Private Goods
How does welfare get maximized? The best possible is to allow everyone to travel and to somehow pay for the bridge.
Price/Fee
Demand/Users Value
# of users
User Fees for Excludable Public Goods and for Publicly Provided Private Goods
Welfare = Cost of the Bridge
Price/Fee
Demand/Users Value
# of users
User Fees for Excludable Public Goods and for Publicly Provided Private Goods
If you charge a fee to recoup the cost of the bridge welfare goes down.
Price/Fee
Demand/Users Value
COST OF BRIDGE FEE
# of users
User Fees for Excludable Public Goods and for Publicly Provided Private Goods
If you charge a fee to recoup the cost of the bridge welfare goes down.
Price/Fee
Demand/Users Value
COST OF BRIDGE FEE
LOST VALUE
# of users
Marginal Benefit
Non-Excludable Marginal Benefit =
How do we know whether we have the socially optimal quantity of public goods?
Marginal Benefit from the public good
= S MU(pg)
How do we know whether we have the socially optimal quantity of public goods?
Marginal Benefit from the public good = S MU(pg) Marginal Cost of Providing one more unit of Public Good = MC(pg) Marginal Benefit from the Private good = MUi Marginal Cost of Providing one more unit of Private Good = MC
Right Mix if
Equivalently
S MU(pg)
MC(pg)
MUi MC
Equivalently
MU(pg) MC(pg)
MUi MC
Equivalently
MU(pg) MC(pg)
MUi MC
Equivalently
MU(pg) MUi
MC(pg) MC
Equivalently
S MRS = MRT
This is called the Samuelson Condition after Paul Samuelson who first noticed it applied.
2.
When it is provided at positive MC people will tend to understate their desire for it hoping to free ride.
We want to find Incentive Compatible Mechanisms i.e. provision schemes where it is in everyones interest to correctly report how much they value the good.
If I submit a bid b > B => I win and pay B (I get v*-B) If I submit a bid b < B => I lose and I get zero.
Case 1: B>v* In this case winning (and bidding above B) will lose me money bidding v* is optimal here.
Clark-Groves Mechanism
This is a process that will get individuals to truthfully to reveal their preferences for the public good.
Step 1 : Individuals report their value for the bridge vi Note : they dont have to report the truth vi vi*
Clark-Groves Mechanism
This is a process that will get individuals to truthfully to reveal their preferences for the public good.
Step 1 : Individuals report their value for the bridge vi Step 2 : Add up the reported values.
Clark-Groves Mechanism
This is a process that will get individuals to truthfully to reveal their preferences for the public good.
Step 1 : Individuals report their value for the bridge vi Step 2 : Add up the reported values. Step 3 : If Sum of Reports Cost of Bridge >0 then build the bridge.
Clark-Groves Mechanism
This is a process that will get individuals to truthfully to reveal their preferences for the public good.
Step 1 : Individuals report their value for the bridge vi Step 2 : Add up the reported values. Step 3 : If Sum of Reports Cost of Bridge >0 Build Bridge If Sum of Reports Cost of Bridge <0 Dont Build
Clark-Groves Mechanism
Step 1 : Individuals report their value for the bridge vi
Step 2 : Add up the reported values.
Step 3 : If Sum of Reports Cost of Bridge >0 Build Bridge If Sum of Reports Cost of Bridge <0 Dont Build Step 4 : If the individuals value was decisive, i.e.
Sum of Others Reports < Cost of Bridge < Sum of all Reports
Clark-Groves Mechanism
Step 1 : Individuals report their value for the bridge vi
Step 2 : Add up the reported values.
Step 3 : If Sum of Reports Cost of Bridge >0 Build Bridge If Sum of Reports Cost of Bridge <0 Dont Build Step 4 : If the individuals value was decisive, i.e.
Sum of Others Reports < Cost of Bridge < Sum of all Reports Charge the individual = Cost of Bridge Sum of others reports
Clark-Groves Mechanism
Optimal to tell the truth.
Let U be the sum of the others reports and let v be my value. If U>Cost: I dont care what I say so reporting truthfully is fine.
Clark-Groves Mechanism
Optimal to tell the truth.
If U+v > Cost > U: Then any report u such that U+u>Cost (or u>Cost-U) will get me utility v (Cost U) >0 . (independent of report!)
=0.
Clark-Groves Mechanism
Properties: (1) Optimal to tell the truth (2) Voter only pays when decisive. (3) Payments < benefits received (4) As population grows less of a problem with excess revenue.