Ch4 Eng

8/4/2020
7.1 Definition of Public

Goods
Public Goods 7.2 Optimal Provision of

Public Goods
7.3 Private Provision of

Public Goods
7.4 Public Provision of

Public Goods
7.5 Conclusion
Public Finance and Public Policy Jonathan Gruber Third Edition Copyright © 2010 Worth Publishers 1 of 23
The Concept of a Public Goods

Competitive markets generally work well, but there is a kind
of goods that markets cannot be expected to handle well:
PUBLIC GOODS
A public good has 2 properties:

1. Non-rivalry in consumption
2. Non-excludability
A private good has 2 properties:

1. Rivalry
2. Excludability
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The Concept of a Public Goods
non-rival in consumption One individual’s

consumption of a good does not affect
another’s opportunity to consume the good.
non-excludable Individuals cannot deny each

other the opportunity to consume a good.
pure public goods Goods that are perfectly

non-rival in consumption and are non-
excludable.
impure public goods Goods that satisfy the

two public good conditions (non-rival in
consumption and non-excludable) to some
extent, but not fully.
Examples of Public Goods
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Remarks
Classification between private and public goods does not
refer possession/ownership
 Private goods do not mean to be produced by private
sector
 Public goods do not need to be provided by public sector.
Classification between pure and impure public goods is
relative. The difference depends on many conditions and
technology.
 For public goods, everyone consumes the same quantity,
but each of them judges different benefits.
Some things are not considered conventionally goods, but
they have the nature of public goods (atmosphere)
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CHAPTER 7 ■ PUBLIC GOODS
Optimal Provision of Public Goods

Optimal Provision of Private Goods Q = QB + QJ
 FIGURE 7-1
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Optimal Provision of Private Goods
Consumers demand different quantities of the good at the same
market price.
The optimality condition for the consumption of private goods is written as:
(1)
Equilibrium on the supply side requires:
(2)
In equilibrium, therefore,

Optimal Provision of Public Goods Q = QB = QJ
 FIGURE 7-2
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The social-efficiency-maximizing condition for the public good is:
(3)
Social efficiency is maximized when the marginal cost is set equal to the
sum of the MRSs, rather than being set equal to each individual’s MRS.
Conclusion
For private goods, Consumers demand different quantities of

the good at the same market price.
For public goods, consumers receive the same quantities, but

each of them judges different benefits.
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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?
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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H M
The Island Wall – graph

Figure 3.1
• Individually, none of the
$900 - families would build a wall
$800 - on their own: MB < MC
$700 -
$600 - MC
$500 -
$400 -
• The MB curves are
$300 -
in a ratio of: 3:2:1
$200 -
MBH
$100 - MBM
I I I I I I I MB L
2 4 6 8 10 12 14 Wall Thickness (ft)
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The Island Wall – graph

Figure 3.1 Summing their marginal benefits,
this public good should be built.
$900 -
 MB > MC
$800 -
But how thick?
$700 -
$600 - MC
$500 -
 MB
$400 - 10 feet thick is the
$300 - socially optimal or
$200 - MBH efficient thickness of
$100 - MBM the wall!!
MBL
I I I I I I I
2 4 6 8 10 12 14 Wall Thickness (ft)
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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Private Provision of Public Goods

Can Private Providers Overcome the Free Rider Problem?
The free rider problem does not lead to a complete absence

of private provision of public goods.
The private sector can in some cases combat the free rider
problem to provide public goods by charging user fees that
are proportional to their valuation of the public good.

When Is Private Provision Likely to Overcome
the Free Rider Problem?
Some Individuals Care More than Others
Private provision is particularly likely to surmount the free rider

problem when individuals are not identical, and when some individuals
have an especially high demand for the public good.
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When Is Private Provision Likely to Overcome
the Free Rider Problem?
Altruism
altruistic When individuals value the

benefits and costs to others in
making their consumption choices.
social capital The value of altruistic

and communal behavior in society.
Public Provision of Public Goods

Private Responses to Public Provision:
The Problem of Crowd-Out
crowd-out As the government

provides more of a public good, the
private sector will provide less.
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Measuring the Costs and Benefits of Public Goods
Should the government undertake highway improvements?
Measuring costs and benefits can be complicated.
What if, without this highway project, half of the workers on the
project would be unemployed? How can the government take
into account that it is not only paying wages but also providing a
new job opportunity for these workers?
What is the value of the time saved for commuters due to reduced
traffic jams? And what is the value to society of the reduced
number of deaths if the highway is improved?

How Can We Measure Preferences for the Public Good?
Preference revelation: individuals may not be willing to tell the

government their true valuation because the government might charge
them more for the good if they say that they value it highly.
Preference knowledge: even if individuals are willing to be honest about

their valuation of a public good, they may not know what their valuation
is, since they have little experience pricing public goods such as highways
or national defense.
Preference aggregation: how can the government effectively put together

the preferences of millions of citizens in order to decide on the value of a
public project?
These difficult problems are addressed by the field of political economy,

the study of how governments go about making public policy decisions
such as the appropriate level of public goods.
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EM P I R I C A L E V I D E N C E
MEASURING CROWD-OUT
A study found that for every $1 increase in government funding for public
radio, private contributions fell by 13.5¢. This is an interesting finding, but it
potentially suffers from bias problems.
In another study, individuals contributed to a public good in a laboratory

setting by contributing tokens they were given to a common fund. A 2-token
tax on every player was then contributed to the public good. Without warm
glow effects, players should have reduced their contributions by 2 tokens.
However, each player cut his or her contributions by only 1.43 tokens.
Laboratory experiments have their limitations as a source of economic

evidence, thus, the true extent of crowd-out remains an important question.
Conclusion
A major function of governments at all levels is the provision of public

goods.
In some cases, the private sector can provide public goods, but in general it
will not achieve the optimal level of provision.
When there are problems with private market provision of public goods,
government intervention can potentially increase efficiency. Whether that
potential will be achieved is a function of both the ability of the government
to appropriately measure the costs and benefits of public projects and the
ability of the government to carry out the socially efficient decision.
12

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8/4/2020

7.1 Definition of Public

Public Goods 7.2 Optimal Provision of

7.3 Private Provision of

7.4 Public Provision of

The Concept of a Public Goods

A public good has 2 properties:

A private good has 2 properties:

The Concept of a Public Goods

non-rival in consumption One individual’s

non-excludable Individuals cannot deny each

pure public goods Goods that are perfectly

impure public goods Goods that satisfy the

Examples of Public Goods

CHAPTER 7 ■ PUBLIC GOODS

Optimal Provision of Public Goods

CHAPTER 7 ■ PUBLIC GOODS

Optimal Provision of Public Goods

Equilibrium on the supply side requires:

CHAPTER 7 ■ PUBLIC GOODS

Optimal Provision of Public Goods

CHAPTER 7 ■ PUBLIC GOODS

Optimal Provision of Public Goods

The social-efficiency-maximizing condition for the public good is:

CHAPTER 7 ■ PUBLIC GOODS

For private goods, Consumers demand different quantities of

For public goods, consumers receive the same quantities, but

CHAPTER 7 ■ PUBLIC GOODS

Who Should Produce a Public Good?

• After the government raises the money for a public

Private Firms? Government?

CHAPTER 7 ■ PUBLIC GOODS

The Island Wall – assumptions

• Merchant ships sell private goods to the families

• Pirates sometimes raid the island

Should a defensive wall (a public good) be built to

CHAPTER 7 ■ PUBLIC GOODS

CHAPTER 7 ■ PUBLIC GOODS

The Island Wall – graph

CHAPTER 7 ■ PUBLIC GOODS

The Island Wall – graph

CHAPTER 7 ■ PUBLIC GOODS

At the efficient, socially optimal quantity of a

At the efficient, socially optimal quantity of a

CHAPTER 7 ■ PUBLIC GOODS

Private Provision of Public Goods

The free rider problem does not lead to a complete absence

CHAPTER 7 ■ PUBLIC GOODS

Private Provision of Public Goods

Some Individuals Care More than Others

Private provision is particularly likely to surmount the free rider

CHAPTER 7 ■ PUBLIC GOODS

Private Provision of Public Goods

altruistic When individuals value the

social capital The value of altruistic

CHAPTER 7 ■ PUBLIC GOODS

Public Provision of Public Goods

crowd-out As the government

CHAPTER 7 ■ PUBLIC GOODS

Public Provision of Public Goods

Should the government undertake highway improvements?

Measuring costs and benefits can be complicated.

CHAPTER 7 ■ PUBLIC GOODS