Roadmap:

Chpt. 10 considered 1 cause of market failure (externalities). Chpt. 11 looks at 2 more:

Public goods and common resources.

Two properties of goods: excludability and rivalry in consumption.

Is a good “excludable”?Is it possible to provide it to some while withholding it from others?

Is a good “rival in consumption”?Does one person’s use of it diminish its potential to be used by others?

“Private goods”: excludable and rival in consumption.

Example: A candy bar.Excludable: Only those who pay get a candy bar.Rival in consumption: If I eat the candy bar, you’re out of luck!

“Public goods”: non-excludable and non-rival in consumption.

It’s not possible to provide it to some whilewithholding it from others . . .

. . . and its use by some doesn’t diminish itspotential to be used by others.

“Classic” example: Lighthouse services.It’s not feasible to turn the light “on” for some ships (those who have paid?) and “off” for others.

When one ship uses the light, it’s value to others is undiminished.

(Note: The text mentions unusual circumstances in which a lighthouse might be a private good.)

Another example:National defense.

Some not-so-clear-cut cases:Scientific research?

If it’s patentable, it’s excludable.

Streets and highways?Sometimes non-excludable and non-rival in

consumption.

But could be excludable (toll roads) . . .. . . and could be rival in consumption

(on congested highways, one more car adds to delay for all.)

“Common resources”: non-excludable and rival in consumption.

Example: A commercial fishery (a region of the ocean that is the habitat for a commercially-valuable species).

Non-excludable: (Assuming no regulation . . .)Anyone can buy a boat, nets, etc.,

and start catching fish.

Rival in consumption: Fishing by one depletes the stock, making fishing less productive for others.

Another example: The Ogallala aquifer (http://www.water . . .)

(Aquifer: Groundwater held in a porous geologic formation. Basically, an underground “lake.”)

Ogallala aquifer underlies portionsof 8 Great Plains states.

Holds about as much water asLake Huron.

Natural recharge: rainfall and snowmelt.

Depletion: pumping from wells for agriculture, municipal water, industry.

Non-excludable: (Assuming no regulation . . . ) Any property owner above the aquifer can drill a well and pump water out.

Most of the groundwater use (about 94%) is due to agriculture: irrigated crop land, cattle feedlots.

Aquifer is between 50 and 300 feet below the surface.

Rival in consumption: Pumping water by one depletes the aquifer, making it harder for others to get water.

(My well might dry up if my neighbor drills a well and starts pumping like crazy.)

Public goods and market failure.

“Free rider”: A person who receives the benefit of a good but avoids paying for it.

The “free-rider” problem usually prevents private (“for-profit”) provision of public goods.

Example: Consider a lighthouse entrepreneur.Incurs cost of building a lighthouse with hope of recovering cost and making a profit by charging a fee for service.

Dear Mr. or Ms. Ship Owner:

I plan to build a lighthouse on “Shipwreck Point.” You, and many others, will benefit from its services. Your share of my costs (including a fair profit) is $500 for the first year of operation. Please use the enclosed postage-paid envelope to send me a check at your earliest convenience.

Regards,

John Schroeter, CEOReliable Lighthouse Company

Each ship owner reasons as follows:

“Because I’m one of many who will benefit, my payment is just a tiny share of total cost. So decision to ‘build’ or ‘not build’ won’t be affected by my decision to pay.”

“But (!) . . . if the lighthouse is built, I can’t be excluded from use of services even if I don’t pay.”

“So why pay? I’ll just ‘free-ride.’”

Result: Free markets rarely provide public goods – even though total benefit exceeds total cost.

Remedy for this market failure?

Usually, public goods are provided by government:

National defense.

Aids to navigation (lighthouses in the “old days” –now GPS satellites).

Government subsidies to basic research.

Unlike private sector firms, government can enforce payments to offset cost of provision through power to tax.

Common resources (non-excludable and rival in consumption) and market failure.

“Tragedy of the commons”: The tendency for common resources to be used more than is desirable from the standpoint of society as a whole.

(http://www.econlib.org/library/ . . .)

Can think of the common resource problem as a conflict between private and social interests (. . .or, between individual and collective interests.)

Example: Ogallala aquifer.

Social interest (interest of all farmers inNebraska

collectively):

Pump groundwater for irrigation “today” . . .

. . . but don’t overdo it! (Maintain the level of the aquifer insuring that there will be groundwater readily accessible for irrigation “tomorrow” too.)

Private interest (interest of each individual farmer):

Pump as much groundwater as I want “today.”

The perspective of an individual farmer:

“I represent only a tiny share of total aquifer depletion. My activity will have a negligible impact on the sustainability of the aquifer. So I might as well use as much of the water as I want now.”

Can also think of this as a negative externality:

Groundwater pumping by one reduces opportunity for all.

If this externality isn’t internalized, excessive depletion results.

Remedies:

Sometimes government regulation:States and water districts in the Great

Plains impose restrictions on the drilling of new wells.

But depletion of Ogallala aquifer continues.(http://www.choicesmagazine.org . . .)

(Some experts predict it may dry up in 25 years.)

Regulation also used to prevent “over-fishing” in commercial fisheries: catch limits, season restrictions, etc.

Sometimes a common resource can be turned into a private good – and the tragedy of the commons avoided – by assigning property rights.

Classic example of a common resource: “the town common”

. . . surrounded by pasture land.

Property in the village is privately owned . . .

. . . but the pasture land is owned in common by all of town’s residents: “the town common.”

A medieval village . . .

The pasture can support a cattle herd, but overgrazing is harmful.

When individual herdsmen decide how many cattle to graze – the benefit of more cattle is a private benefit . . .

. . . but the cost of overgrazing is shared by all.

Outcome: Too many cattle resulting in the tragedy of the commons.

Solution: Divide the town common into private parcels of land – establish “property rights.”

Now each individual herdsman internalizes the costs of too many cattle.

Overgrazing is avoided.

“What is common to many is taken least care of, for all men have greater regard for what is their own than what they possess in common with others.” -- Aristotle