PUBLIC GOODS AND

POLITICAL ECONOMY
 THE CONCEPT OF PUBLIC GOODS
 TWO PROPERTIES:
 NONEXCLUDABLE - means that it is hard to exclude any person from benefiting from the
good or service even if the person won’t pay for it.
 NONRIVALRY - means that consumption of the good or service by one person does not
prevent consumption of the good by other people; in fact, all individuals simultaneously
consume the same quantity of the good.
 Example: National defense is a public good: If a military force is established, equipped, and
stands ready to defend the nation, it is hard to exclude any person from being defended;
moreover, the quantity of defense is the same for all people.
 Example: Police protection from criminals is a public good: If police deter potential criminals
and apprehend actual criminals, it is hard to exclude any person from being protected.
 PRIVATE GOODS
 a private good has excludability—it is easy to exclude a person from benefiting from the good
or service if the person refuses to pay for it, and it has rivalry—consumption of the good by one
person prevents consumption by other people. A private good is consumed by only one person.
 Some goods or services have one of the two properties but not the other. A cable TV program is
excludable but not rival: It is easy to exclude someone who refuses to pay from receiving the
program; but one person’s watching (consuming) the program does not prevent another from
watching it.
 NONEXCLUDABILITY, FREE-RIDER, AND TAXATION
 Non-excludability implies that it may be hard to get some individuals to voluntarily pay an
adequate share of the cost of a public good because they know that they can’t be excluded from
benefiting if the good is produced. True, some individuals will voluntarily pay because they
believe it is morally right to contribute—they get a warm glow from doing the right thing. If
national defense were funded by voluntary contributions rather than taxes, some individuals
would donate large sums and many individuals would contribute something. Another reason
some individuals contribute voluntarily is because they are altruistic —they are willing to
contribute to help others in need. Large sums are voluntarily donated to charities by some
individuals, and many individuals donate something. Thus, it is certainly true that there would
be substantial voluntary donations to finance many public goods.
 NONEXCLUDABILITY, FREE-RIDER, AND TAXATION
 without taxes, some individuals would choose to be free riders —people who reason, “I’ll let
others pay and then enjoy the benefits.” True, if everyone tries to free ride, there would be no
public goods supplied because no one would be willing to pay for them. Yet each free rider
reasons this way: “If others pay and I don’t, the public good will be supplied and I’ll benefit.
But if I pay and others don’t, very little of the public good will be supplied and I’ll hardly
benefit.
 The standard approach to the free-rider problem is taxation. Since everyone benefits, everyone
should be compelled to contribute. The compelling must be done by the government, and the
compulsory payment is called a tax.
 WHO SHOULD PRODUCE PUBLIC GOODS?
 Why does the government buy planes produced by private firms instead of producing its own
planes?
 One reason is that there is a large market for planes in the private sector. Private airlines buy a
large number of planes to serve a huge number of private airline passengers. Air travel is a
private good—if you refuse to pay, you won’t be 60 Public Finance allowed on the plane—so
there is a large private sector that provides air travel. Consequently, private firms are already
producing a large number of planes for the private sector. Competition among these firms has
improved their efficiency. It therefore makes sense for the government to take advantage of this
efficiency by purchasing planes from these firms rather than producing its own planes.
 ACTIVITY
 IN REAL LIFE LIST AT LEAST 5 EXAMPEL OF THE FOLLOWING:
 ALTRUISTIC
 FREE RIDERS
COST-BENEFITS ANALYSIS
 COST BENEFITS ANALYSIS
 Cost-benefit analysis is the measuring of the costs of a project and the benefits of a project to
help decide whether to undertake the project and what the scale of the project should be.
Consider these decisions facing government: Should a particular highway be built? Should
improvements be made in a highway to make it safer? How much should carbon fuel use be cut
(through a carbon tax or permits) to reduce global warming? Should Medicare pay for costly
treatment X? Should a military intervention be undertaken? In these and many other decisions,
economists recommend weighing cost against benefit to help guide the decision. In this chapter,
using these examples, we examine how cost-benefit analysis can help us arrive at better
decisions in the public sector.
 COST BENEFITS ANALYSIS
 The basic principle of cost-benefit analysis is simple:
 A project should be undertaken if its benefit to society exceeds its cost to society. The scale of such
a project should be increased as long as the marginal social benefit (MSB) exceeds the marginal
social cost (MSC) so that the optimal scale occurs where MSB equals MSC.
 COST BENEFITS ANALYSIS
 The basic principle of cost-benefit analysis is simple:
 A project should be undertaken if its benefit to society exceeds its cost to society. The scale of such
a project should be increased as long as the marginal social benefit (MSB) exceeds the marginal
social cost (MSC) so that the optimal scale occurs where MSB equals MSC.
 Private firms and individuals use cost-benefit analysis all the time. Firm managers compare the cost
of a new factory or machine to its benefit: the increase in future profits.
 PRIVATE FIRM
 BUILDING A FACTORY - Consider a firm with expanding demand for its product. With its
current factory the firm is already producing at capacity, so to take advantage of the expanding
demand, the firm would have to build another factory. To decide whether it is worth building
another factory, the firm must compare the cost of building the factory with the benefit—the
additional profit that can be made by producing and selling more. In order to keep things as
simple as possible, we assume there is no taxation.
 GOVERNMENT
 BUILDING A HIGHWAY - The same logic and analysis applies when the investment project is
undertaken by government. While private firms invest in factories, government invests in
infrastructure, such as roads and bridges. Let’s consider the use of cost-benefit analysis to
evaluate the construction of a highway. The cost of the highway has two components:
construction costs (e.g., labor, equipment, and asphalt) and future maintenance (repair) costs.
Computing the present value by “discounting” future maintenance costs, and adding
construction costs, gives the present value of the cost of the highway.
 There are at least three ways for the cost-benefit analyst to estimate the benefit to commuters:
increased output, actual market behavior ( revealed preference) , and hypothetical questions and
answers ( contingent valuation) . Let’s consider each in turn.
 GLOBAL WARMING
 Cost-benefit analysis can also be applied to a broader issue like global warming. How much
should each country cut back on its emission of greenhouse gases such as carbon dioxide in an
effort to combat global warming? Cutting back is costly—carbon fuel combustion must be
reduced, thereby reducing driving and goods that are produced using fuel. Assume such a
cutback is likely to reduce global warming in the future. Such a reduction in warming would
benefit many (though not all) countries. Cutting back should occur as long as the marginal cost
of further cutback is less than the marginal benefit of further reduction in future warming.