AEC02: PRINCIPLES OF ECONOMICS

Public Goods and Common

Resources
Engr. Czarina Catherine L. San Miguel
(Instructor)
The Different Kinds of
Goods
• When thinking about the various goods in the economy, it is useful to group them
according to two characteristics:

1. Excludable
 the property of a good whereby a person can be prevented from using it

2. Rivalry in Consumption
 the property of a good whereby one person’s use diminishes other people’s
use
• When thinking about the various goods in the economy, it is useful to group them
according to two characteristics:

1. Excludable
 the property of a good whereby a person can be prevented from using it

2. Rivalry in Consumption
 A rival good is a type of product or service that can only be possessed or
consumed by a single user. When a good is rival in consumption, it may be
subject to strong demand and fierce competition—factors that tend to drive
up prices.
The Different Kinds of Goods
 Private Goods

• Goods that are both excludable and

rival in consumption

• These are goods that behave

"normally" regarding supply and
demand
 Public Goods
• Goods that are neither excludable nor
rival in consumption.

• That is, people cannot be prevented

from using a public good, and one
person’s use of a public good does
not reduce another person’s ability to
use it.
 Public Goods
• In economics, a public good refers to a commodity or service that is made available
to all members of society. Typically, these services are administered by governments
and paid for collectively through taxation.

• Examples of public goods include law enforcement, national defense, and the rule of
law. Public goods also refer to more basic goods, such as access to clean air and
drinking water.
 Public Goods
• The Free-Rider Problem

• A free rider is a person who receives the benefit of a good but does not pay for it.

• A free rider is a person who benefits from something without expending effort or
paying for it. In other words, free riders are those who utilize goods without paying
for their use
 Public Goods
• Example of Free Rider:
• National defense also gave rise to free-riders. Whether taxpayers or not, all
received the same protection from the police and the army. Of course, when
saving you on the road from crime, the police will not ask you whether you paid
taxes or not before helping you.
 Public Goods
• The Free-Rider Problem

• The free-rider problem is the burden on a shared resource that is created by its
use or overuse by people who aren't paying their fair share for it or aren't paying
anything at all.
 Public Goods
• The Free-Rider Problem

• The free-rider problem can occur in any community, large or small. In an urban
area, a city council may debate whether and how to force suburban commuters to
contribute to the upkeep of its roads and sidewalks or the protection of its police
and fire services. A public radio or broadcast station devotes airtime to fundraising
in hopes of coaxing donations from listeners who aren't contributing.
 Public Goods
• The Free-Rider Problem

• The free-rider problem is an issue in economics. It is considered an example of a

market failure. That is, it is an inefficient distribution of goods or services that
occurs when some individuals are allowed to consume more than their fair share of
the shared resource or pay less than their fair share of the costs.
 Public Goods
• Possible solutions for free riders:
1. Collect taxes.
• Governments can collect taxes and use them to provide public services. For
example, by requiring everyone to pay taxes, the government could finance
national defense. And, if everyone paid taxes, there would be no free riders.
 Public Goods
• Possible solutions for free riders:
2. Excluding nonpayers.
• We can prevent nonpayers from using the product. In other words, we turn
public goods into club goods.

3. User contributions.
• Suppliers provide a common platform where users (beneficiaries) contribute
to each other to develop the platform.
 Common Resources
• Goods that are rivals in consumption
but not excludable

• For example, fish in the ocean are

rivals in consumption: When one
person catches fish, there are fewer
fish for the next person to catch. But
these fish are not an excludable good
because it is difficult to stop fishermen
from taking fish out of a vast ocean.
 Common Resources
• A common resource is one that can provide benefit to society but which is not owned
by anybody in particular.

• Because anybody can enjoy its use in common, the risk of over-consumption and
ultimate depletion of common resources is a big concern.

• This concern has been formalized under the concept of the "tragedy of the
commons."
 Common Resources
• Tragedy of the Commons
A parable that illustrates why common resources are used more than is desirable
from the standpoint of society as a whole

The tragedy of the commons is a problem in economics that occurs when

individuals neglect the well-being of society in the pursuit of personal gain.

This leads to over-consumption and ultimately depletion of the common resource,

to everybody's detriment.
 Common Resources
• Tragedy of the Commons
For a tragedy of the commons to occur a resource must be scarce, rivalrous in
consumption, and non-excludable.
Solutions to the tragedy of the commons include the imposition of private property
rights, government regulation, or the development of a collective action
arrangement.
 Club Goods
• Goods that are excludable but not rival
in consumption

• These goods exhibit high excludability

but low rivalry in consumption.
Because the low rivalry in consumption
means that club goods have essentially
zero marginal cost, they are generally
provided by what is known as natural
monopolies.
AEC02: PRINCIPLES OF ECONOMICS

Cost of Production
Engr. Czarina Catherine L. San Miguel
(Instructor)
 What are Costs?
• Total revenue
 the amount a firm receives for the sale of its output

• Total cost
 the market value of the inputs a firm uses in the production

• Profit
 total revenue minus total cost
 Costs as Opportunity Costs
• Explicit costs
Input costs that require an outlay of money by the firm
Examples of explicit costs include wages, lease payments, utilities, raw materials,
and other direct costs

• Implicit costs
Input costs that do not require an outlay of money by the firm
Examples of implicit costs include the loss of interest income on funds and the
depreciation of machinery for a capital project.
 The Cost of Capital as an
Opportunity Cost
• An important implicit cost of almost every business is the opportunity cost of the
financial capital that has been invested in the business
 Economic Profit versus Accounting
Profit
• Economic profit
Total revenue minus total cost,
including both explicit and implicit
costs

• Accounting profit
Total revenue minus total explicit
cost Economists versus Accountants
• Economists include all opportunity costs when analyzing a
firm, whereas accountants measure only explicit costs.
• Therefore, economic profit is smaller than accounting profit.
 Economic Profit versus Accounting
Profit
• Economic profit
 It is the difference between total monetary revenue and total costs, but total costs
include both explicit and implicit costs.
 Economic profit includes the opportunity costs associated with production and is,
therefore, lower than accounting profit.
 Economic profit also accounts for a longer span of time than accounting profit.
Economists often consider long-term economic profit to decide if a firm should enter or
exit a market
 Economic Profit versus Accounting
Profit
• Accounting profit
 It is the difference between total monetary revenue and total monetary costs, and is
computed by using generally accepted accounting principles (GAAP).
 It is the same as bookkeeping costs and consists of credits and debits on a firm’s balance
sheet. These consist of the explicit costs a firm has to maintain production (for example,
wages, rent, and material costs). The monetary revenue is what a firm receives after
selling its product in the market.
 Accounting profit is also limited in its time scope; generally, accounting profit only considers
the costs and revenue of a single period of time, such as a fiscal quarter or year.
 Production and Costs
• Firms incur costs when they buy inputs to produce the goods and services that they
plan to sell.
 • The Production Function
Output
Total Cost of
(quantity of Marginal
Number of Cost of Cost of Inputs (cost of
cookies Product of
Workers Factory Workers factory + cost
produced per Labor
of workers
hour) Table 1. A Production
0 0 $30 30 $30 Function and Total Cost:
50 Caroline’s Cookie Factory
1 50 30 10 40
40 Table 1 shows how the
2 90 30 20 50 quantity of cookies
30 produced per hour at
3 120 30 30 60 Caroline’s factory depends
20 on the number of workers
4 140 30 40 70
10
5 150 30 50 80
5
6 155 30 60 90
 Production and Costs
• The Production Function

• The figure presents a graph of the two columns of

numbers (number of workers and output).

• The number of workers is on the horizontal axis, and the

number of cookies produced is on the vertical axis.

• This relationship between the quantity of inputs

(workers) and quantity of output (cookies) is called the
production function.
 • The Production Function
Output
Total Cost of
(quantity of Marginal
Number of Cost of Cost of Inputs (cost of
cookies Product of
Workers Factory Workers factory + cost
produced per Labor
of workers
hour)
0 0 $30 30 $30
Marginal product
50
1 50 30 10 40
40 It is the increase in the
2 90 30 20 50 quantity of output obtained
30
3 120 30 30 60 from one additional unit of
20
that input.
4 140 30 40 70
10
5 150 30 50 80
5
6 155 30 60 90
 • The Production Function
Output
Total Cost of
(quantity of Marginal
Number of Cost of Cost of Inputs (cost of
cookies Product of
Workers Factory Workers factory + cost
produced per Labor
of workers
hour)
Diminishing marginal
0 0 $30 30 $30
50
product
1 50 30 10 40
40 It is the property whereby
2 90 30 20 50 the marginal product of an
30
3 120 30 30 60 input declines as the
20
quantity of the input
4 140 30 40 70
10 increases
5 150 30 50 80
5
6 155 30 60 90
 Production and Costs
• Total cost curve

• The total-cost curve shows the relationship between the

quantity of output produced and total cost of production.

• Here, the quantity of output produced (on the horizontal

axis) is from column (2) in Table 1, and the total cost (on
the vertical axis) is from column (6).

• The total-cost curve gets steeper as the quantity of output

increases because of diminishing marginal product
 TABLE 2: The Various Measures of Costs: Conrad’s Coffee Shop
Output
Average Fixed Average Variable Average
(cups of coffee per Total Cost Fixed Cost Variable Cost Marginal Cost
Cost Cost Total Cost
hour)
0 $3.00 $3.00 $0.00 - - -
$0.30
1 3.30 3.00 0.30 $3.00 $0.30 $3.30
0.50
2 3.8 3.00 0.8 1.5 0.4 1.9
0.7
3 4.5 3 1.5 1 0.5 1.5
0,90
4 5.4 3 2.4 0.75 0.6 1.35
1.1
5 6.5 3 3.5 0.6 0.7 1.3
1.3
6 7.8 3 4.8 0.5 0.8 1.3
1.5
7 9.3 3 6.3 0.43 0.9 1.33
1.7
8 11 3 8 0.38 1 1.38
1.9
9 12.9 3 8 0.38 1 1.38
2.1
10 15 3 12 0.3 1.2 1.5
 The Various Measures of Costs
• Conrad’s Total-Cost Curve

• Here the quantity of output produced (on the

horizontal axis) is from column (1) in Table 2, and
the total cost (on the vertical axis) is from column
(2).

• The total-cost curve gets steeper as the quantity of

output increases because of diminishing marginal
product
 Fixed and Variable Costs
• Fixed costs
Costs that do not vary with the quantity of output produced

They are incurred even if the firm produces nothing at all.

Example: Conrad’s fixed costs include any rent he pays because this cost is the
same regardless of how much coffee he produces. Similarly, if Conrad needs to
hire a full-time bookkeeper to pay bills, regardless of the quantity of coffee
produced, the bookkeeper’s salary is a fixed cost. The third column in Table 2
shows Conrad’s fixed cost, which in this example is $3.00.
 Fixed and Variable Costs
• Variable costs
Costs that vary with the quantity of output produced

Example: Conrad’s variable costs include the cost of coffee beans, milk, sugar,
and paper cups: The more cups of coffee Conrad makes, the more of these items
he needs to buy. Similarly, if Conrad has to hire more workers to make more cups
of coffee, the salaries of these workers are variable costs. Column (4) in the table
shows Conrad’s variable cost. The variable cost is 0 if he produces nothing, $0.30
if he produces 1 cup of coffee, $0.80 if he produces 2 cups, and so on.
 Fixed and Variable Costs
• Total costs
A firm’s total cost is the sum of fixed and variable costs.
 Average and Marginal Cost
• Average total cost
total cost divided by the quantity of output
It tells us the cost of the typical unit, but it does not tell us how much total cost will
change as the firm alters its level of production.

𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑡𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡=𝑇𝑜𝑡𝑎𝑙𝑐𝑜𝑠𝑡/𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦

𝐴𝑇𝐶=𝑇𝐶 /𝑄
 Average and Marginal Cost
• Average fixed cost
• Fixed cost divided by the quantity of output

• Average variable cost

• Variable cost divided by the quantity of output

• Marginal cost
• The increase in total cost that arises from an extra unit of production
𝑀𝑎𝑟𝑔𝑖𝑛𝑎𝑙 𝑐𝑜𝑠𝑡=𝐶h𝑎𝑛𝑔𝑒 𝑖𝑛𝑡𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡/ 𝐶h𝑎𝑛𝑔𝑒 𝑖𝑛𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦
M
 Economies and Diseconomies of
Scale
• Economies of scale
The property whereby long-run average total cost falls as the quantity of output
increases

• Diseconomies of scale
The property whereby long-run average total cost rises as the quantity of output
increases
 Economies and Diseconomies of
Scale
• Constant returns to scale
The property whereby long-run average total cost stays the same as the quantity
of output changes
 Assignment
(Deadline of submission: May 21, 2022 (Saturday), 8:00AM)

1. Jane’s Juice Bar has the following cost schedules. Calculate average variable cost,
average total cost, and marginal cost for each quantity.
Quantity Variable Cost Total cost
0 vats of juice $0 $30
1 10 40
2 25 55
3 45 75
4 70 100
5 100 130
6 135 165
 Assignment
(Deadline of submission: May 21, 2022 (Saturday), 8:00AM)

2. You are the chief financial officer for a firm that sells digital music players. Your firm has the
following average-total-cost schedule:
Quantity Average Total Cost
600 players $300
601 301

Your current level of production is 600 devices, all of which have been sold. Someone calls,
desperate to buy one of your music players. The caller offers you $550 for it. Should you
accept the offer? Why or why not?