Externalities and Public Goods - Des Moines Area Community College

[Pages:24]Externalities and Public Goods

Four Categories of Goods

Goods differ on the basis of whether their consumption is rival and excludable.

Rival ? The situation that occurs when one person's consuming a unit of a good means no one else can consume it.

If you eat a hamburger, no one can eat the same unit of that hamburger.

Excludable ? The situation in which anyone who does not pay for a good cannot consume it.

If you don't pay for a hamburger, you could be excluded from consuming it.

Four Categories of Goods

1. Private Good ? a good that is both rival and excludable.

Food, clothing, personal electronics, cars, etc. The market is good at providing private goods

2. Public Good ? a good that is both nonrival and nonexcludable.

National defense, court system, lighthouses, streetlights, flood-control levees etc.

The market typically under-provides these goods or not at all since they are nonexcludable. It is difficult for a firm to make a profit off of providing them. People can consume these types of goods without paying for them, which is known as free riding.

Free rider problem - Benefiting from a good without paying for it. The mandate in the ACA is supposed to help remedy the problem of uncompensated expenses for health care.

The government provides public goods and partially resolves the free rider through taxation.

Four Categories of Goods

3. Quasi-Public Good / Club Good ? a good that is excludable, but not rival.

Cable TV, uncongested toll roads, uncongested beach that required a fee, cinemas, etc.

4. Common Property Resource ? a good that is rival, but nonexcludable.

International fish stocks, public pasture land, free water use, hunting and trapping, etc.

Four Categories of Goods

Excludable

Nonexcludable

Rival Nonrival

Private Goods: Pizza Tennis Rackets Shoes Quasi-Public Goods: Cinemas Uncongested Toll Road Internet

Common Resources: International Fish Stocks Public Pasture Lands Public Goods: National Defense Court System Lighthouse

Demand for a Public Good

The demand for a public good is similar to the demand for a private good. It is the aggregation of all individual demand curves (or marginal benefit curves).

The optimal quantity of a public good is where the marginal social benefits equal the marginal social costs.

This is also where consumer and producer surplus is maximized.

Demand for a Public Good

However, there is little to no incentive for an individual to reveal their true preferences regarding a public good since once it is supplied they cannot be excluded from consuming it.

In addition, public goods are often supplied to many people and it is difficult and time consuming to determine each individual's marginal private benefit curve.

Demand for a Public Good

The government typically resorts to cost-benefit analysis when supplying a public good or some sort of political process.

Congress and the President do not use a formal cost ? benefit analysis to determine the optimal level of military spending.

Other times, public goods are left up to a referendum.

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