Public Goods and Common Resources

Dr. Katherine Sauer Principles of Microeconomics ECO 2020

Recall: In markets, prices act as signals. - cost of production - value to buyers What about goods/services that are not sold in markets? Ex: basic research - quantify costs (lab equipment, scientist salary, etc) - buyers dont purchase basic research What about goods that are communally owned? Ex: air, fish in the ocean - property rights are not well-defined

These types of goods create positive externalities: - have value yet have no price (not sold in the marketplace) These externalities mean that left on its own, the market outcome is not efficient. - potential reason for government intervention

I. Classifying the Types of Goods/Services When classifying types of goods in the economy, two characteristics should be examined. excludability: the property of a good whereby a person can be prevented from using it rivalry in consumption: the property of a good whereby one persons use diminishes other peoples use Using these two characteristics, we can divide all goods/services into 4 categories.

4 Types of Goods 1. private goods are both excludable and rival in consumption. ex: haircut, ice cream cone, congested toll road 2. public goods are neither excludable nor rival in consumption. ex: tornado siren, national defense, uncongested nontoll road 3.common resources are rival in consumption but not excludable. ex: fish in the ocean, the environment, congested nontoll road 4. club goods are excludable but not rival in consumption. ex: fire protection, cable TV, uncongested toll road

The boundary between the categories is sometimes fuzzy. Whether goods are excludable or rival in consumption is often a matter of degree.

II. Public Goods Example: a fireworks display - not excludable because it would be nearly impossible to keep others from viewing it - not rival in consumption because one persons enjoyment does not preclude others from enjoying it More examples: - highway snow removal - flood control - mosquito control - fighting poverty - national defense - basic research

Public Goods suffer from the free rider problem. A free rider is a person who receives the benefit of a good but avoids paying for it. - non-excludable If a good is not excludable, then how would a firm make a profit selling it? Markets fail to provide goods that are not excludable. - governments may provide - nonprofit organizations or charities may provide

A government should only provide a non-excludable good if the public benefit is greater than the cost. - use cost-benefit analysis Cost-Benefit analysis can be difficult: - Cost of provision can usually be estimated (monetary cost). - Benefits are very hard to quantify (not market based).

Ex: Should a traffic light be installed at an intersection? - light costs $30,000 to $140,000 - traffic light decreases chance of death in a particular intersection by 1% Do the benefits outweigh the costs?

Note: Just because the government provides a good doesnt mean it is a public good. ex: education - excludable - somewhat rival in consumption Note: Just because the government provides a good doesnt mean they actually need to produce it themselves.

III. Common Resources A common resource is a good that everyone has access to but is not unlimited in quantity. ex: wildlife, fish in the ocean, air Since common resources are non-excludeable and rival, they may be overused or exploited. - overgrazing - over fishing - deforestation - pollution

The Tragedy of the Commons illustrates that when private incentives differ from social incentives, people will act in their own best interest to the detriment of society. - private incentive is to take as much as possible - social incentive is to take as much as is sustainable

Classic Story: In medieval Europe, shepherds would share a common piece of land and were entitled to graze their sheep on it. An individual shepherd had an incentive to increase his flock size as much as possible. However, the grazing land can only support so many sheep.

When a shepherd gets a new sheep, he grazes it on the land. - he gets the entire benefit from the sheep - the damage to the commons is shared by everyone When individual shepherds are making economically rational decisions, they will all try to graze as many sheep as possible, which will destroy the commons. When the commons are depleted, all the shepherds are then worse off.

Some potential solutions: - regulations - permits - taxes - privatize property rights - (social norms) (Millions of cows are slaughtered every year, why isnt the cow extinct?) It is the absence of property rights that leads to market failure in the case of common resources.

Chapter Summary: Goods differ in whether they are excludable and whether they are rival in consumption. Markets work best for goods that are excludable.

Public goods are neither rival in consumption nor excludable. - non-excludable . free-rider problem Governments often provide public goods. -based on costbenefit analysis

Common resources are rival in consumption but not excludable. Because private incentives differ from social incentives, common resources tend to be excessively used. - government intervention