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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 cant. Some public goods are non-rival and non-excludable, but also are avoidable. For example, a broadcast radio program is both non1

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

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

. In

public goods, and would not achieve a Pareto optimal distribution of utilities (a distribution on the utilities possibilities curve). To understand the difference between the conditions that need to be satisfied for economic efficiency for public (non-rival) goods and private (rival) goods, lets plan a party. At the party you will serve hot dogs (rival good) and display fireworks (non-rival good). You will have ten guests, and for simplicity, suppose guests are of two different types. The following tables show the MWTP for hotdogs (X) and fireworks displays (G) for the two types of guests. 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, so you are not going to charge them, but you dont want to waste money, so you do not want to buy hot dogs or fireworks that your guests value less than what it is going to cost you. What to do?


#fireworks displayed at party



#fireworks displayed at party


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

different consumers. Diagrammatically, the community demand (MWTP) curve for a private (rival) good is obtained by horizontally summing the demand (MWTP) curves of the consumers. That is, you sum quantities which are measured on the horizontal axis. For a non-rival good G, you sum the MWTPs of everyone in the community. That is, MWTP MWTP a bcMWTP .. . Further,
.. . quantity of the non-rival good. If you have three fireworks displays,


MWTP G everyone can consume the total. . That is,


everyone gets to enjoy all three. 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, or price, is measured on the vertical axis.) Now go back to the party example, 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. Public Good Efficiency Conditions: A Diagrammatic Explanation In the diagram below, we derive the efficiency conditions for a public good G using the standard diagrammatic tools of production possibility curves (PPC) and indifference curves. In the top panel, we measure total output of a public good G on the horizontal axis. On the vertical axis we measure the total output of a private good X as given by the PPC. This represents the limits the economy can produce. We want to find the Pareto Optimal output of G, thus we want to make one of the agents (B) the best off she can be without harming the other agent (A). To ensure that we do not harm A, we make sure A. As 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.
A , and given that G must be Given the PPC, given that A must be on U the same for both agents, what is available for B? We show that in the second panel with the curve RR (R stands for remainder). 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

to keep her on U A . We obtain RR by subtracting the U curve from the PPC.

A indifference

Now what is the efficient level of G? You might think it is where the RR curve is highest (maximum), but that is wrong. Why? Because to find a Pareto optimal (efficient) level of G we want to maximize Bs utility, not how much private good she has. The efficient level of G, denoted G*, is where the RR curve is tangent to Bs highest B ). 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 . Since we obtain the RR curve by subtracting U PPC, its slope (magnitude) is equal to MOC -MWTP GA . At G*, G MRS B =MO G -MWTP GA , which can be rearranged as MWTPC +MWT GB =MO G . GA P C As they say in the Math department, QED.

(Diagram on next page.)

Of course, in both panels, there are lots and lots of indifference curves. We only show the relevant indifference curves for each agent.






G* R R

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. Assume two households and a linear production possibilities curve. Household A has utility function U AX G where X A is As consumption of the A private good and G is the economy-wide amount of the public good. . As MWTP for the public Household B has utility function U BB X good is MWTP A G

and Bs is

curve of the economy is

XG 2 120



1 . The production possibilities X X X



A) What is the MOC of the public good? B) Write down the efficiency condition for the public good and simplify it. C) For a level of G satisfying this condition, how much utility does A get? This is an expression, not a number. D) Suppose all of the societys resources are used to please household A. How much utility does each household get? (Note, B does not get zero utility). E) Suppose all of societys resources are used to please B, 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. 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), how much utility does B get? I) Is this utilities distribution on the UPC? Answers next page

A) According to the PPC, an extra unit of G would reduce X by 2 units, so the MOC of the public good is 2. B) Set the sum of .This implies that C) Setting

and MWT


equal to 2. That is,


1 2

, we see that

A D) If all resources are used to please A, then . ( X B 0 ). Setting XX XG in the PPC equation, we find G*=40. Both households get 40 units of utility. (Note that B still gets to consume the public good even though it gets no private good.)


E) Now X AA G 0 , so U B 120 . U X B F) U BXA G X X . Since XG 120 2 and X AA G , the G U UPC can be expressed for U A 40 . Illustrated below. U B A 120
UB 120
U 2


40 U

G) If G is equal to 20, then A gets utility of 20. According to the UPC, B gets utility of 120 minus two times 20, which is 80. You can confirm

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