Chapter 4

SV3
Public Goods

Learning Objectives

Define public goods and their

characteristics
Explain the difference between pure public
goods and pure private goods
Congestible Public Goods
Derive the demand curve for a pure public
good
Determine the conditions for efficient
output of a pure public good
Analyze the free rider problem
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Public Goods

Public Goods are goods for which

exclusion is impossible.
One example is National Defense: A
military that defends one citizen
from invasion does so for the entire
public.

Characteristics of Public Goods

Non-exclusion: The inability of a seller to

prevent people from consuming a good if
they do not pay for it.
The benefits derived from the provision of pure
public goods cannot be confined to only those
who have actually paid for it. In this sense, nonpayers can enjoy the benefits of consumption at
no financial cost to themselves this is known as
the free-rider problem and it means that
people have a temptation to consume without
paying!
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Characteristics of Public Goods

Nonrivalry: The characteristic that if one

person consumes a good, another persons
pleasure is not diminished, nor is another
person prevented from consuming it.
Consumption of a public good by one person does
not reduce the availability of a good to everyone
else therefore we all consume the same amount
of public goods even though our tastes and
preferences for these goods (and therefore our
valuation of the benefit we derive from them)
might differ

Example of Public Goods

flood control systems

public water supplies
street lighting for roads and
motorways
lighthouse protection for ships
national defence services.
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Pure Public Goods and Pure Private

Goods

Pure Public Good: No ability to exclude

and no rivalry for benefits.
Pure Private Good: Clear ability to
exclude and rivalry for benefits.

Figure 4.1 Marginal Costs of Consuming and

Producing a Pure Public Good-Figure A

Cost (Dollars)

200

Marginal Cost of Allowing an

Additional Person to Consume a
Given Quantity of Pure Public Good
falls to zero after its is made available
to any one person
0

Number of Consumers
8

Figure 4.1 Marginal Costs of Consuming and

Producing a Pure Public Good--Figure B
Marginal Cost of Producing
a Pure Public Good
Cost (Dollars)

200

MC = AC
Marginal cost of producing the good is always
positive. In this case, the MC of each extra unit of the
good is $200.

0 Units of a Pure Public Good per Year

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Price Excludable Public Goods

Price-excludable public good: there are

external benefits when produced or
consumed but exclusion is easy.
Examples: Private clubs are often set
up share facilities, such as tennis
courts, swimming pools and dining
areas for small groups

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Congestible Public Goods

There are public goods where, after a

point, the enjoyment received by the
consumer is diminished by crowding or
congestion. These are called
Congestible Public Goods.

Examples:
roads- congested road decreases the
benefit to existing users by slowing down
traffic and increasing the risk of an
accident
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Figure 4.2 A Congestible Public Good

Marginal Cost

The MC of allowing additional users to

consume the congestible public good falls to
zero after the good is made available to an one
user but then rises above zero after N* users are
accommodated per hour

Marginal Cost per User

Number of Consumers per Hour

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Figure 4.3 Classifying Goods According to the Degree of

Rivalry and Excludability of Benefits from Their Use
1

A
C

Excludability

B
0

Rivalry

1
13

 A pure public good corresponds to point b,

where there is no rivalry for benefits and excludability from
benefits is impossible.
A pure private good corresponds to point A on the graph
A non rival good such as TV transmission, for which
exclusion is possible, corresponds to a point like C
A congestible public good for which it is possible to
charge for use, such as a limited access highway,
corresponds to a point like H

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Demand For a Pure Public &

Private Goods

Demand for a Pure Public Good is

derived by adding how much people
will be willing to pay at each
quantity.
Market demand for a Pure Private
Good is derived by adding quantities
demanded at each price
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Marginal Benefit (Dollars)

Figure 4.5 Demand For A Pure Public Good

800
700
600
500
400
300
200
100
0

Z1

The demand curve for a pure public good is

obtained by summing the individual
marginal benefit at each quantity
Z2
Z3
Z4
D= MBA
DA = MBA
DB = MBB
DC = MBC

1
2
3
4
Security Guards per Week

5
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Efficient Output of a Pure Public

Good

The socially optimal level of the public good

requires that we set the Marginal Social
Benefit of that good equal to its Marginal
Social Cost. MSB = MSC

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Marginal Benefit (Dollars)

Figure 4.6 Efficient Output for a Pure Public Good

800
700
600
500
400
300
200
100
0

MC = AC = MSB
D= MBi = MSB
MBA
MBB
MBC

1
2
3
4
Security Guards per Week

5
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Price per Loaf of Bread (Dollars)

Figure 4.4 Demand For a Private Good

The demand for a private good is obtained by
adding the quantities demanded by each
consumer at each possible price.The efficient
output is six units per week, which correspond to
point E. At a price of $3 per loaf,
Mba=MBb=MBc=MC

7
6
5
4

S = MC = AC
D = QD

DC = MBC
DB = MBA
DA = MBA

2
1
0

Loaves of Bread Purchased per Week

10
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Recall from Figure 4.5 that the

marginal social benefit for a
Mathematically: Lindahl Pricing
pure public good is the sum of
the individual marginal
benefits.
That is:
MSB = MB.
Efficient output is therefore:
MSB = MB = MSC.
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A Numerical Example
Number of Security Guards per Week
1
2
3
4
MBA

$300

$250

$200

$150

MBB

$250

$200

$150

$100

MBC

$200

$150

$100

$50

MB

$750

$600

$450

$300

If the cost of security guards is $450 per week, then no individual will
hire even one guard, even though to the group one guard is worth
$750. The group should hire three.
If they each pay their marginal benefit, then three guards are hired.
Person A pays $600 ($200 per guard), person B pays $450 ($150 per
guard) and person C pay $300 ($100 per guard).

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Lindahl Equilibrium

Definition

A circumstance where the amount produced and consumed

of a public good is adjusted to the price that individuals are
able and willing to pay for that specific good.
Substantial adjustments need to be made between the
supply, demand and cost of the public good before the
point where a balance or equilibrium is reached where all
these elements are in agreement. The end result is that the
public good or public need is met by balancing the price
to one that private individuals can pay.
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Lindahl Equilibrium

The amount each person contributes, ti,

depends on individual desires for the public
good.
The sum of the contributions equals the total
cost of the public good.
StiQ* = MC(Q*) = AC(Q*)

Sti = MC = AC

All individuals agree to pay their shares.

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Freeriding

DEFINITION of 'Free Rider Problem'

1. In economics, the free rider problem refers to a situation

where some individuals in a population either consume

more than their fair share of a common resource, or pay
less than their fair share of the cost of a common
resource.
2. In the context of a brokerage firm, a free rider
problem refers to a situation where a client has been
allowed to purchase shares without actually paying for
them, and then subsequently sells the shares (ideally for
profit).
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Freeriding

Freeriding occurs when people

are not honest in stating their
Marginal Benefit, because if
they understate it, they can get
a slightly reduced level of the
public good while paying
nothing for it.
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Freeriding is easier with

Anonymity: If everyone knows who

contributes, there can be powerful social
stigmas applied to shirkers.

Large numbers of people: Its easier to

determine the shirkers in a small group and
the punishment is more profound when
people close to you shun you for not paying
your share.
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Tutorial
Three individuals' demand schedules for a good are shown in the table below.
Assume these are the only individuals in the society
Price

Q (Lynn)

Q (Mark)

Q (Peter)

14

13

12

11

10

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QUESTION

a. If this

is a private good, what is the total quantity demanded at a

price of $13?What is the total quantity demanded at a price of $11?
The total quantity demanded is the sum of the quantities demanded
by each of the three individuals at a given price. At a price of $13,
the total quantity demanded is 3: 2 from Lynn, 0 from Mark, and
1 from Peter. At a price of $11, the total quantity demanded is
8: 4 + 1 + 3 = 8.
b. Assuming this is a private good, determine the optimal quantity
of the good if its marginal cost is constant and equal to $10.
The optimal amount occurs where price and marginal cost are
equal. Since marginal cost is $10, price must be $10. At this
price, the total quantity demanded is 11 units = 5 + 2 + 4.
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c.Now assume this is a public good. What is the marginal

benefit of the second unit of this good? What is the
marginal benefit of the third unit? The fourth unit?
The marginal benefit of any particular unit is the sum
of the values placed on that unit by each of the
individuals. In this example, the marginal benefit of
the second unit is $35: $13 by Lynn, $10 by Mark,
and $12 by Peter.
The marginal benefit of the third unit is $32 = $12 +
$9 + $11. The marginal benefit of the fourth unit is
$29 = $11 + $8 + $10
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d. If the marginal cost is constant and equal to

$30, determine the optimal quantity of this
public good.
Comparing marginal benefit to marginal
cost, the third unit should be provided, as
its marginal benefit of $32 exceeds its
marginal cost of $30. However, the
fourth unit should not be provided as its
marginal benefit is less than its marginal
cost: $29 is less than $30

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Discussion question
1. Summarize the main differences between pure private and
pure public goods. Explain why in case of pure public goods
private markets are likely to fail to achieve efficiency.
Answer: Obviously the answer is built around whether a good
is rival or non-rival and whether it is excludible. There are
only a few pure public goods, most goods have only some
characteristics of a public good.

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Discussion question
Question: What is the characteristics of Pure Public Good
Answer: Pure public good is non-excludable and non-rival in
consumption.
Non-excludable
means that if one of the consumers purchases one unit of the
good, the other consumer will be able to consume that unit as well
and there is no way to preclude the second consumer from
enjoying the benefits.
Non-rival
means that the fact that the second per-son is consuming the good
does not diminish the benefits to the first person. When you construct
the market demand for public good use the notion of `maximum
amount all consumers will be willing to pay in order to purchase an
additional unit'.
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THANK U

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