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Topic 3: The Efficient Quantities of Private and Public Goods Goods are efficiently provided when the MWTP

for the good is equal to the MOC. We will see now that this is true for both public and private goods, but with a difference. The difference results from the different properties of public and private goods. The Properties of Private and Public Goods Pure private goods (which include most market goods) are rival , which means that a unit of a private good cannot be consumed by more than one consumer at a time. In other words, if there are 100 units of a pure private good available in an economy, and one person consumes 40 units, then there are at most 60 units available for everyone else. Pure private goods are also excludable , which means that owners of the good (perhaps those who produced it) can prevent (exclude) people from consuming it unless they pay for it, and they can do so at low cost. This requires a system of property rights and a means of enforcement to prevent people from consuming the good without paying for it. We have a word for failing to pay for a good that belongs to someone else-stealing. Pure private goods, usually, are also avoidable. That is, people who do not like the good do not have to consume it. By contrast, a pure public good is non-rival , which means that every unit of the good can be consumed by everyone in the economy at no additional cost. If there are 100 units of a public good available in an economy, everyone can consume 100 units of the good, no matter how many people there are in the economy. A pure public good is also non-excludable , which means that anyone can consume the good without paying for it. A pure public good cannot be “stolen”. Thus, anyone who produces a public good has no way to charge for it, which begs the question why produce it? In some cases, public goods are also non-avoidable , which means that consumers who do not like the good cannot avoid consuming it. For such consumers, the public good is not a good at all it is a “bad”. They would prefer not to consume it, but can’t. Some public goods are non-rival and non-excludable, but also are avoidable. For example, a broadcast radio program is both non1

Be sure to understand the difference between a public good and a publicly (government) provided good. or non-rival but excludable. Other examples of public goods include a lighthouse (a more up to date example is a GPS satellite). Highways are an example of a congestible public good. Many. For example. housing. For example. non-excludable (it is not possible to demand a fee from a person on the street for the benefit of the streetlight and deny consumption to those who won’t pay). knowledge. education and garbage collection. When a rival. no one else can consume the same slice) . national defense. broadcast TV programs. The above describes the properties of pure private and public goods. pizza is rival (if one person eats a slice. not whether it is provided by private firms or the government. .) are there such people? you Other examples of private goods include clothing. excludable (if you don’t pay the pizza delivery guy he won’t give you the pizza don’t like pizza ) and avoidable (if you don’t have to consume it.). Most of these are market goods. In general. flood 2 . Some goods have a mixture of these properties. They are called congestible public goods. electricity. Most. streetlights are non-rival (they light the street for anyone and everyone who walks on it). but if you do not like the music. but not all. you can tune it out. education. cannot avoid them. bicycles. fuel. airplane seats. and non-avoidable (people who find the streetlights annoying. Once the road becomes congested. One motorist’s use of it highway is uncongested. we will refer to such goods as mixed or impure public goods (see topic 5). have the properties that make them public goods. the use by one motorist slows down and reduces the value of the road to other motorists. It is the properties of the good that determine whether it is private or public. For example they may be rival but non-excludable. such as nearby astronomers who wa nt a “dark sky” so they can see the stars. it is nondoes not prevent another from using it too. Some public goods become rival as more and more people consume them.rival and non-avoidable. although the government is involved in the provision of health care. but certainly not all. market goods are private goods. healthcare. garbage collection. goods provided by government.

like poor people should have access. For another. private goods can be efficiently provided through a decentralized market system that rations and finances the availability of the good through a price system. an economy would not provide efficient quantities of 3 . the conditions for the efficient provision of private and public goods are quite different. Thus. Why does it matter whether a good is private or public? For one thing. It depends on the population to which the non-rival.control. and for ozone layer protection. or should be public goods. merit goods explain why governments may provide some private goods. If a good is rival. such as broadcast TV programs may be provided by private firms. others. and environmental quality like clean air. like a city park or police protection. non-excludable TV program. The Efficiency Conditions for Private and Public Goods. is that right? To educate more students. for national defense it is the citizens of the nation. Note that public goods. like the national defense or the Center for Disease Control. Some of these public goods are provided by government. Often people assert that health care and education are public goods. we must have more teachers and more school space. Without government. like preventing global warming or preserving the ozone layer that protects us from harmful radiation from the sun. unlike merit goods. For police protection it is the local citizens. what does it mean to say it should be nonrival? What people probably mean is that access to goods like person’s education and health care should not be limited by a ability to pay for them. it is the citizens of the world. Economists call such goods merit goods effect. Given the definition of a public good. non-excludable good is available. which typically require public financing (taxes). In . are defined by objective criteria non-rivalry and non-excludability. Why would private firms provide a non-rival. Some public goods are described as local public goods. Others are national public goods. and still others are world public goods. volcano monitoring. Merit goods are defined by normative (value) criteria. so education is most certainly rival. Such arrangements are not usually possible for public goods. merit goods are private (non-rival) goods that most people think should not be rationed using the price mechanism.

At the party you will serve hot dogs (rival good) and display fireworks (non-rival good). To understand the difference between the conditions that need to be satisfied for economic efficiency for public (non-rival) goods and private (rival) goods.public goods. and for simplicity. The following tables show the MWTP for hotdogs (X) and fireworks displays (G) for the two types of guests. You will have ten guests. suppose guests are of two different types. but you don’t want to waste money. What to do? 4 MWTP X #fireworks displayed at party MWTP G MWTP X #fireworks displayed at party MWTP G . Type I Guests (5 of them) #hot dogs eaten per guest 1 $3 1 $4 2 $2 2 $3 3 $1 3 $2 4 $0 4 $1 Type II Guests (5 of them) #hot dogs eaten per guest 1 $5 1 $2 2 $4 2 $1 3 $3 3 $0 4 $2 4 -$1 You want your guests to be happy. lets plan a party. and would not achieve a Pareto optimal distribution of utilities (a distribution on the utilities possibilities curve). so you are not going to charge them. so you do not want to buy hot dogs or fireworks that your guests value less than what it is going to cost you.

Why must the MWTP for a rival good be the same for all consumers? Because if one person has a higher MWTP for a rival good than another person has. the party is getting stale.. When you have to start paying your guests to hang around. That . (Notice that your type II guests th display would need to be paid $1 each to watch a 4 so don’t go there. because the good is rival. For the third (and last) display that you purchase. On the other hand. Thus. for any type of good.. the efficient quantity requires that MWTP MOC where MWT is the “community” MWTP and MOC is the cost to society of an P extra unit. Give it to a person who values it at $3. b. What about fireworks. and the common MWTP is the community MWTP. a unit of rival good can be enjoyed by only a one consumer. Each of your type II guests is willing to pay $2 for their 4 st through 3 rd) . You should continue this until the MWTPs are the same for everyone.. Q Q Q Qb c . it is efficient for first person to consume more of the good (the higher MWTP represents a use of the good that has higher economic value) and the second person should consume less. your type I guests get $10 worth of fun.Suppose hot dogs cost $2 how many should you buy? Answer: th hot 30. where a. is. you’ ll certainly buy that. so you buy 20 to split among dog (and more for the 1 them. The collective MWTP of your guest for the first fireworks display is $30--5 times $4 for type I guests plus 5 times $2 for type II guests. More generally. How many should you buy? Answer: 3 displays. c denote X x X X 5 . which cost you $10 per display? Unlike hotdogs. For a rival good X. and your type II guests are bored (but indifferent). the total quantity consumed is equal to the sum of the quantities consumed by all consumers. fireworks are a non-rival good each fireworks display benefits all the guests at your party. c efficiency requires that MWTP X X X MWTP a bMWTP . Do not waste your money feeding a $2 hot dog to someone who values it at only $1. Remember. everyone who consumesMWTP X (rival) good must have the a private same MWTP. while each of your type I guests is willing to pay $2 for their st ) so you need 10 dogs to split 2nd hot dog (and more for their 1 among them. It is this community MWTP which must equal MOC at the efficient quantity of X. . Since a fireworks display costs you $10.

G G G everyone gets to enjoy all three. A . we derive the efficiency conditions for a public good G using the standard diagrammatic tools of production possibility curves (PPC) and indifference curves. abc QQQQ GGGG MWTP G everyone can consume the total. and determine that these efficiency conditions and summing conventions apply to the case of hot dogs and fireworks displays when you plan your party with 30 hot dogs and 3 fireworks displays.. or price. you sum the MWTPs of everyone in the community. Further.) Now go back to the party example. the community demand (MWTP) curve for a private (rival) good is obtained by horizontally summing the demand (MWTP) curves of the consumers. To ensure that we do not harm A. Public Good Efficiency Conditions: A Diagrammatic Explanation In the diagram below. For a non-rival good G. MWTP MWTP a bcMWTP .different consumers. we make sure A. you sum quantities which are measured on the horizontal axis. We want to find the Pareto Optimal output of G. If you have three fireworks displays. On the vertical axis we measure the total output of a private good X as given by the PPC. That is. given that A must be on U the same for both agents. is measured on the vertical axis. we measure total output of a public good G on the horizontal axis. . This represents the limits the economy can produce. . . quantity of the non-rival good. Diagrammatically. The B) RR curve shows how much B can consume of the private good (X at each level of G when we allocate enough of the private good to A 6 . . thus we want to make one of the agents (B) the best off she can be without harming the other agent (A). That is. A’s consumption of the she is on a given indifference curve U private good (X A ) is also measured on the vertical axis in the top panel. That is. what is available for B? We show that in the second panel with the curve RR (R stands for remainder). In the top panel. and given that G must be Given the PPC. Diagrammatically.. the community demand (MWTP) curve for a public (non-rival) good is obtained by vertically summing the demand (MWTP) curves of the consumers (because the MWTP.

The efficient level of G. denoted G*. its slope (magnitude) is equal to MOC -MWTP GA . Why? Because to find a Pareto optimal (efficient) level of G we want to maximize B’s utility. Since we obtain the RR curve by subtracting U PPC. in both panels. there are lots and lots of indifference keep her on U A . but that is wrong. GA P C As they say in the Math department.) 1 Of course. We obtain RR by subtracting the U curve from the PPC. is where the RR curve is tangent to B’s highest B ). not how much private good she has. G MRS B =MO G -MWTP GA . At G*. 1 indifference curve (shown as U B is MRS B which is also We know that the slope (magnitude) of U A from the MWTP G B . A indifference Now what is the efficient level of G? You might think it is where the RR curve is highest (maximum). which can be rearranged as MWTPC +MWT GB =MO G . 7 . QED. (Diagram on next page. We only show the relevant indifference curves for each agent.

X. XA PPC UA G B X UB G* R R G 8 .

not a number. How much utility does each household get? (Note. B does not get zero utility). D) Suppose all of the society’s resources are used to please household A. how much utility does A get? This is an expression. Assume two households and a linear production possibilities curve. A’s MWTP for the public Household B has utility function U BB X good is MWTP A G G XA and B’s is curve of the economy is XG 2 120 G MWT P B G 1 . C) For a level of G satisfying this condition. how much utility does B get? I) Is this utilities distribution on the UPC? Answers next page 9 . A) What is the MOC of the public good? B) Write down the efficiency condition for the public good and simplify it. .Public Good Efficiency and the Utilities Possibilities Curve Working out this problem and thinking about what is happening will help you understand public good efficiency better. Household A has utility function U AX G where X A is A’s consumption of the A private good and G is the economy-wide amount of the public good. G) Suppose G=20 and the economy is on the UPC. how much utility does each household get? H) Suppose G=10 and household A gets the same utility as in part E). The production possibilities X X X AB where . how much utility does each household get? household F) Now write down an expression for the utility possibilities curve in this economy and draw the UPC. E) Suppose all of society’s resources are used to please B.

B) Set the sum of . U B A 120 UB 120 U 2 40 40 U A G) If G is equal to 20. then A gets utility of 20. B gets utility of 120 minus two times 20. which is 80. E) Now X AA G 0 . U X B F) U BXA G X X . an extra unit of G would reduce X by 2 units.This implies that C) Setting XA G MWT P G X A G A and MWT P B G equal to 2. the G U UPC can be expressed for U A 40 . Since XG 120 2 and X AA G . XA G . so U B 120 . That is. so the MOC of the public good is 2. 1 2 . we find G*=40. then . ( X B 0 ). Both households get 40 units of utility. According to the UPC. (Note that B still gets to consume the public good even though it gets no private good.) UA G G 2 .A) According to the PPC. Illustrated below. Setting XX XG in the PPC equation. we see that A D) If all resources are used to please A. You can confirm 10 .

it is inside the UPC because the efficiency condition is not satisfied. producing G at an inefficient level permits the possibility of increasing the utility of B without harming A. Thus B gets 60 units of the private good and 10 units of the public good for a utility of 70. (Confirm this.this.) Thus. Efficiency requires that X A be equal to G. H) If G is 10 then total output of the private good is 100. which is less than 80. If G is 20 then X is 80 according to the PPC. so B gets 60 units of private good and 20 units of public good for a utility of 80. If A gets 20 units of utility. The public good efficiency condition means Pareto optimality. I) No. it must consume 40 units of the private good. or 20. 11 .