Chapter-Two: Public & Private Goods

1. Public Goods:

A public good is a good that is both non-excludable and non-rival in that individuals cannot be
effectively excluded from use and where use by one individual does not reduce availability to
others.

Gravelle and Rees: "The defining characteristic of a public good is that consumption of it by
one individual does not actually or potentially reduce the amount available to be consumed by
another individual". Common examples of public goods include: defense, public fireworks,
lighthouse, national defense. Public goods also refer to more basic goods, such as
access to clean air and drinking water.. Some goods, like orphan drugs, require special
governmental incentives to be produced, but can't be classified as public goods since they don't
fulfill the above requirements (non-excludable and non-rival.) Law enforcement, streets,
libraries, museums, and education are commonly misclassified as public goods.

2. Private Goods:

A private good is a good that is both excludable and rival in that individuals can be effectively
excluded from use and where use by one individual reduces availability to others.

A product that must be purchased in order to be consumed, and whose consumption by one
individual prevents another individual from consuming it is called private goods. Economists
refer to private goods as "rivalrous" and "excludable". If there is competition between
individuals to obtain the good and if consuming the good prevents someone else from consuming
it, a good is considered a private good. Common examples of private goods include: Ice-cream
cones, Clothing etc.

3. Four types of goods:

i. Public Goods iii. Natural Monopoly

ii. Private Goods iv. Common Resources

NON-RIVAL RIVAL

NON-EXCLUDABLE National defence Cable TV

Pure Public Good
EXCLUDABLE Fish in the ocean
(Impure Public Good)
Common Resources
(Impure Public Good)
Natural Monopoly
Clothes
Pure Private Good

 Excludable
A good is excludable if only the people who pay for it are able to enjoy its benefits. Brinks’s
security services, East Point Seafood’s fish, and a Coldplay concert are examples.

 Non-excludable
A good is non-excludable if everyone benefits from it regardless of whether they pay for it. The
services of the LAPD, fish in the Pacific Ocean, and a concert on network television are
examples.

 Rival
A good is rival if one person’s use of it decreases the quantity available for someone else. A
Brinks’s truck can’t deliver cash to two banks at the same time. A fish can be consumed only
once.

 Non-rival
A good is non-rival if one person’s use of it does not decrease the quantity available for someone
else. The services of the LAPD and a concert on network television are non-rival.

4. Free Rider:

In economics, the free rider problem occurs when those who benefit from resources, goods, or
services do not pay for them, which results in either an under-provision of those goods or
services, or in an overuse or degradation of a common property resource. The free rider problem
is the question of how to limit free riding and its negative effects in these situations. The free
rider problem may occur when property rights are not clearly defined and imposed

The economic problem with free riding: Free riding is considered an economic problem when
it leads to the non-production or under-production of a public good, a situation known as a
Pareto inefficiency, or when free riding leads to the excessive use of a common property
resource. Providing public goods fairly is difficult because the group leadership does not have
the required information. When people are asked how much they value a particular public good,
with that value measured in terms of how much money they would be willing to pay, their
tendency is to underestimate.

Public goods are characterized by the inability to exclude non-payers. This problem is
compounded by the fact that common-property goods are characterized by rival consumption.
Not only can consumers of common-property goods benefit without payment, but consumption
by one imposes an opportunity cost on others. This will lead to overconsumption and even
possibly exhaustion or destruction of the common-property good. If too many people start to free
ride, a system or service will eventually not have enough money to operate.

Possible solutions: Government is the primary agency that societies utilize to address the free
rider problem. Regulation is a form of action taken by governments to resolve free rider
problems to prevent environmental degradation or excessive resource use. Practical tacts include
compulsory participation (taxation) or a form of regulation and linking the public good to a
desirable private good (getting people to pay voluntarily). Governments have imposed taxes
when not enough people have voluntarily paid for a public good or service, and some
governments have turned a public good into a private one.

Others:

Altruistic: When individuals value the benefits and costs to others in making their consumption
choices.

Warm glow model: A model of the public goods provision in which individuals care about both
the total amount of the public good and their particular contributions as well.

5. Problems or obstacles at the time of public policy decisions:

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.

6. Criteria/factors have to be considered at the time of government action:

 Cost-benefit: Do benefits to society exceed costs? (No distribution considerations)

Those benefiting could compensate losers.

 Pareto (optimal): Do at least some members of society benefit without any losing out?

 Majority rule (democracy): Do more members of society benefit than lose?

 Oligarchic (elite rule): Do those who control society benefit?

 Social justice (re-distributive): Do worse off members of society benefit?

 Individual Benefits from the Project

Individual Individual Cost Individual Individual Benefit-Based

Benefit Share Gain Share of Total Cost Share
Benefits

A 3,000 2,500

B 5,000 2,500

C 8,000 2,500

D 3,000 2,500

E 1,000 2,500

Total 20,000 12,500

Math Part

Problem-01: Calculate the benefit-based cost share for each individual.

Hints:
 First, calculate the percent share of the total benefit for each individual:

Individual Benefit
Individual Share of Total Benefit =
Total Benefit

For example, for Individual A, the Individual Share of Total Benefit is:

3,000
=0.15 (or 15%)
20,000

 Next, calculate the benefit-based cost share for each individual:

For example, for Individual A, the benefit-based cost share is:

0.15× 12,500 = 1,875

 Problem-02: Calculate the benefit-based cost share for each individual.

Individual Benefits from the Project

Individual Individual Cost Individual Individual Benefit-Based

Benefit Share Gain Share of Total Cost Share
Benefits

A 12,000 6000

B 8,000 6000

C 3,000 6000

D 10,000 6000

E 7,000 6000

Total 40,000 30,000

7. Why public goods are necessary in the economy? Or benefits of public goods. (Self)
 APPLICATION

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.