Chapter 16Chapter 16

Public Goods and Public ChoicesPublic Goods and Public Choices

Private Goods, Public Goods, and In Between

• Private Goods: Rival and exclusive– Pizza– Sodas– Shoes

• Public Goods: Non-rival and non-exclusive– Public Defense– Parks

Private Goods, Public Goods, and In Between

• For-profit firms can’t profitably sell public goods.– Thus, the government comes to the rescue by

providing public goods and paying for them through enforced taxation.

– Sometimes non-profit firms provide these goods.

Private Goods, Public Goods, and In Between

• In Between: non-rival but exclusive– Cable– Internet

• These are natural monopolies

• Rival but nonexclusive– Hunting– Fishing

• They are nonexclusive in that it would be costly if not impossible for a firm to prevent access to these goods

Open-access goods

• A good that is rival in consumption but non-payers cannot be excluded easily.

LO1

Categories of Goods

Exhibit 1

Optimal Provision of Public Goods• Non-rival in consumption

– Once produced, the good is available in that amount to all consumers.

• Market Demand Curve– The vertical sum of each consumer’s demand for the

public good.• Efficient level of the public good

– Market demand curve intersects the marginal cost curve

– Where the sum of the marginal valuations equals the marginal cost

LO1

Market for Public Goods

Because public goods, once produced, are available to all in identical amounts, the demand for a public good is the vertical sum of each individual’s demand.

The efficient level: MC of mosquito spraying equals its marginal benefit; at point e, where the marginal cost curve intersects the market demand curve.

The market demand for mosquito spraying (D) is the vertical sum of Maria’s demand, Dm, and Alan’s demand, Da.

Exhibit 2

Paying for Public Goods

• The efficient approach would be to impose a tax on each resident equal to his or her marginal valuation.

• Problem with this:– Once people realize their taxes are based on

government estimates of how much they value the good, they will understate their true valuation.

• Thus, they create a free-rider problem.

– The ability to pay the tax

Free-Rider Problem

• Because a person cannot be easily excluded from consuming a public good, some people may try to reap the benefits of the good without paying for it.– Going to a park outside of your town.

Median-Voter Model

• The median-voter is the one whose preferences lie in the middle of all voters’ preferences.– It predicts that under certain conditions, the

preference of the median, or middle, voter will dominate other choices.

Special Interest

• Rational self-interest assumption of economic behavior– Elected officials try to maximize their political

support– How?

• Cater to special interests rather than serve the interest of the public

Rational Ignorance

• Why don’t consumers stop this behavior?– They consume so many different products that

they have neither the time nor the incentive to understand the effects of public choices on every product.

– Tiny possibility of influencing public choices– So, what do they do?

• Rational ignorance: they remain largely oblivious to most public choices.

• MC>MB for each public choice

Rational Ignorance

• Because information and the time required to acquire and digest it are scarce, consumers concentrate on private choices rather than public choices.

• The payoff is more immediate, more direct, and more substantial.

Distribution of Benefits and Costs

• Four possible categories of distribution:– Widespread benefits and widespread costs– Concentrated benefits and widespread costs– Widespread benefits and concentrated costs– Concentrated costs and concentrated benefits

Traditional public-goods legislation

• This legislation involves widespread costs and widespread benefits-nearly everyone pays and nearly everyone benefits.– National defense

Special-interest legislation

• Benefits are concentrated but costs widespread– These usually harm the economy on net, because

total costs often exceed total benefits– Pork-barrel spending: special-interest legislation

with narrow geographical benefits but funded by all taxpayers.

Populist legislation

• Legislation with widespread benefits but concentrated costs.– Because the small group that bears the cost is savvy

about the impact of the proposed legislation but those who would reap the benefits remain rationally ignorant, populist legislation has little chance of approval.

– The only way such measures get approved is if some political entrepreneur raises enough visibility about the issue to gather public attention and votes.

Competing-interest legislation

• Legislation that confers concentrated benefits on one group by imposing concentrated costs on another group.– Labor unions vs. employers– Steel makers vs. GM

LO2

Categories of Legislation Based on the Distribution of Costs and Benefits

Exhibit 3

Rent Seeking

• Special-interest groups seek some special advantage or some outright transfer or subsidy from the government– Rents: An amount that exceeds what the producer

would require to supply the product.– Rent Seeking: the activity that interest groups

undertake to secure these special favors from government

Rent Seeking

• These special interest groups shift resources from productive endeavors that create output and income to activities that focus more on transferring income to their special interests.

LO2C

ase

Stu

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Farm Subsidies

The Agricultural Marketing Agreement Act, 1937 Prevent ‘ruinous competition’ One in four Americans: farm Floor prices

2007 One in fifty Americans: farm

$18 billions a year

LO2C

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Farm Subsidies

To subsidize farmers, consumers pay Higher product price For the surplus (taxpayers) For storage (the government buys

the surplus) E.g. milk

Free market p=$1.50 Subsidized p=$2.50+$2.50+$0.50

Farmers: normal profit

LO2

Effects of Milk Price Supports

0 75 100 150Millions of gallons per month

$2.50

1.50

Dol

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per

gal

lon

S

D

Excess quantity supplied

No government intervention: market price = $1.50 per gallon, and 100 million gallons are sold per month.

Government: floor price = $2.50 per gallon, quantity supplied increases and the quantity demanded decreases.

To maintain the higher price, the government must buy the excess quantity at $2.50 per gallon.

Exhibit 4

Example of Farm Subsidies-”Stossel in the Classroom”

Example of Farm Subsidies-”Stossel in the Classroom”

The Underground Economy

• Does a tax discourage production?– When a government taxes more, less production

takes place.– Underground Economy: an expression used to

describe market activity that goes unreported either because it is illegal or because those involved want to evade taxes.

• Tips

What are the effects of taxing productive activities?

• Two Effects:– Resource owners may supply less of the taxed

resource because the after-tax wage declines.– To evade taxes, some people shift from the

formal, reported economy to an underground, “off the books” economy.

When do underground economies grow?

• Government regulations increase• Tax rates increase• Government corruption is more widespread

Ownership and Funding of Bureaus

• Bureaus: government agencies charged with implementing legislation and financed by appropriations from legislative bodies– They do not have to meet a market test– Different incentives than for-profit firms

Ownership and Organizational Behavior

• Because public goods and services are not sold in markets, government bureaus receive less consumer feedback and have less incentive to act on any feedback they do receive.

• Because the ownership of bureaus is not transferable, there is less incentive to eliminate waste and inefficiency.

Bureaucratic Objectives

• The traditional view is that bureaucrats are “public servants,’ who try to serve the public as best they can.– Is this realistic?