Market Failure and the Role of Government: Public Goods AP
MICROECONOMICS MR. BORDELON
Slide 2
Characteristics of Goods
Slide 3
Excludable. Suppliers of the good can prevent people who dont
pay from consuming it. Rival in consumption. Same unit of the good
can not be consumed by more than one person at a time. Example. A
car dealership sells a car to Tom at a price of $20,000. Tom gets
the car because he is willing and able to pay that price. The
seller does not sell a car to Becky because Becky considers that
price to be out of her budget. The car is excludable. This means
that the seller does not have to provide a car to Becky or the rest
of the people in town who are unwilling and unable to pay the going
price. Once Tom has purchased the car, the car is his. In other
words, he has consumed this unit of that good and thus prevents
Huck from buying it off of the car lot. Of course Tom could give
Huck a ride, or sell the used car to Huck, but once he sells it to
Huck it now belongs to Huck. Tom cannot sell it to Huck and also
sell it to Becky. Private Goods
Slide 4
Non-excludable. Anyone can consume it. Non-rival in
consumption. Good can be consumed by more than one person at the
same time. Example. Cities have fire departments that protect all
homes in the city and cant exclude anyone on the basis of payment.
And more than one person can consume the fire protection at the
same time. If a fire breaks out at Margarets house, the fire
department rushes to put it out. This prevents the fire from
spreading to Melanies store, so both people are consuming the same
unit of fire protection. Public Goods
Slide 5
Excludable. Non-rival in consumption. Example. A college
economics lecture is excludable because only students who have paid
tuition can enroll in the course and attend the lecture. However it
is non-rival because many people can consume the same unit of the
good at the same time. Other examples are pay-per-view movies or
sporting events. Artificially Scarce Goods
Slide 6
Non-excludable. Non-rival in consumption. Example. The stock of
salmon in the Pacific Ocean has historically been a common
resource. If a person had a boat, they could harvest salmon from
the ocean, or even scoop the fish from the bank of a river as the
salmon headed upstream. This made the salmon non-excludable.
However once a salmon is caught, it cannot be caught by a second
person, which makes it rival. Common Resources
Slide 7
Markets are efficient except in the case of market power,
externalities or other instances of market failure. Markets can
only supply goods and services efficiently if the goods are
excludable and rival in consumptionprivate goods. Free rider. Goods
that are non-excludable suffer from this. Individuals have no
incentive to pay for their own consumption and instead will take a
free ride on anyone who does pay. Markets Supply Only Private Goods
Efficiently
Slide 8
With public goods, the non-exclusive nature of the goods and
the free-rider problem will prevent an efficient quantity from
being produced in a market. So much so that zero units may be
produced (or not, as it were). Markets Supply Only Private Goods
Efficiently
Slide 9
Artificially scarce goods face a similar problem with respect
to free- riders. Example. Pay-per-view of $10 per game. Because
this is greater than zero, fewer consumers will purchase the game
and the number of units consumed will be less than the efficient
quantity. The efficient quantity would be zero assuming this was
not pay-per-view. More than one person can consume this good
despite the $10 excludable price tag. Markets Supply Only Private
Goods Efficiently
Slide 10
Private goods dont have this problem. Firms can charge a price
and thus have an incentive to produce them. Goods are rival,
consumers have an incentive to pay a positive price for them. If
firms have an incentive to offer a good at a price above zero and
there are enough consumers willing to pay that price a market will
emerge for the good. Markets Supply Only Private Goods
Efficiently
Slide 11
There are really only a small number of ways in which a good is
supplied: by private firms or by the government. Private firms wont
supply public goods, so that leaves voluntary contributions or the
government. Research for disease prevention is a public good that
requires a lot of money to provide. Some of those funds are donated
by citizens and corporations, but the government must provide the
rest. Example. National defense is a public good that could not
survive on voluntary donations so the government provides all of
it. Government provides public goods by collecting taxes from the
population. Providing Public Goods
Slide 12
Streetlights along a city street are a public good. How many
lights should be provided in the city? Suppose that Bob and Sandy
are the only residents and that they truthfully tell the government
how much they would be willing to pay for each streetlight. This
willingness to pay (WTP) is also each residents marginal private
benefit (MPB) to having the next light installed. What is the first
streetlight worth to this town? Bob: $10 Sandy: $18 Total marginal
private benefit (MPB): $28 How Much of the Public Good Should be
Provided?
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StreetlightsBobs MPBSandys MPBMSB = MPB B + MPB A 1$10$18$28
281523 361218 44913 5268 How Much of the Public Good Should be
Provided? How many should be installed? The answer lies with the
MSC of the lights. If each light cost the town $12, the first four
will be installed because MSB > MSC, but the fifth would not
because it is inefficient. Even assuming Bob or Sandy was a free
rider, the results would be the same because it was a public
good.
Slide 14
Lets look it from a graph perspective. This curve represents
Teds MPB. As you can see, the benefit decreases with each
additional street cleaning. Notice that the MPB decreases with each
additional street cleaning. How Much of the Public Good Should be
Provided?
Slide 15
Alice has a similar MPB curve, declining according to her own
personal benefit. How Much of the Public Good Should be
Provided?
Slide 16
Putting both Ted and Alice together, we can create the marginal
social benefit curve (total benefit to both). Here, we have a MSC
of $6, meaning it costs $6 per street cleaning. How much would we
produce? How Much of the Public Good Should be Provided?
Slide 17
We would produce 5, where the MSB > MSC. Once we go past 5,
it actually costs society more to produce, effectively a loss of $4
per street cleaning when producing 6. How Much of the Public Good
Should be Provided?
Slide 18
AP Examples: Fish, oceans, clean air, clean water,
biodiversity. The biggest problem with common resources is overuse.
Because they are non-excludable and rival in consumption,
competitors will overuse the resource. Want a good website to
illustrate this: http://www.bunnygame.orghttp://www.bunnygame.org
Common Resources
Slide 19
We live in Florida and we get most of our fresh water from the
aquifer. If I drill a well for my own personal use, its
non-excludableothers can consume this water. For every gallon I
use, however, its one that someone else can not useits rival. My
consumption of water drops the aquifer, making it more costly for
others to get their water. My MPC of the next gallon of water is
lower than the MSC. The socially optimal quantity of water is less
than the market quantity of water. This tells us that a common
resource will be overused. If rainfall is insufficient to recharge
the aquifer, we will exhaust it. Common Resources
Slide 20
Graphing it out, we see this problem of overuse. MSC will
eventually cross the supply curve, and exhaust the resource.
Anytime the Q OPT of a common resource is less than the Q MKT, then
the common resource will be over used. Common Resources
Slide 21
These solutions should look familiar (think negative
externalities): Tax or otherwise regulate the use of the common
resource. Create a system of tradable licenses for the right to use
the common resource. Make the common resource excludable and assign
property rights to some individuals. Efficient Use and Maintenance
of a Common Resource
Slide 22
Pay-per-view movies are artificially scarce because they are
excludable but non-rival. The cable company can exclude me from
watching the movie if you dont pay the price, and if you watch the
movie it doesnt deny another household from also watching the
movie. The marginal cost of providing the movie to one more
household is zero. The efficient quantity would be the quantity
where the demand curve intersects the horizontal axis and the price
would be zero. Of course there is no way the firm can profit if the
price is zero, so the firm sets a price of maybe $5 and excludes
some of the potential customers. If the price is $5, fewer movies
will be ordered than the efficient number. This is why this good is
called artificially scarce. Artificially Scarce Goods