Chapter 11 The Economics of the Public Sector

Private companies invest in medical research if -they will produce general knowledge. -they will produce a specific product for which they may receive a patent. -there is no government intervention in the market for medical products. -others will benefit from their discoveries.

they will produce a specific product for which they may receive a patent. Self interest is what motivates economic exchange, not benevolence.

Market failure associated with the free-rider problem is a result of -a problem associated with pollution. -benefits that accrue to those who don't pay. -losses that accrue to providers of the product. -market power.

-benefits that accrue to those who don't pay. Reason: A fireworks display in Triangle Park in downtown Lexington can be observed by people across the city, so it would be difficult to charge money for it.

Refer to Table 11-4. Suppose the cost to plant each tree is $340 and the 4 homeowners have agreed to split all tree-planting costs equally. Which homeowner(s) would be in favor of planting at least 1 tree? -only Benitez -only Benitez and Chen -only Benitez, Chen, and Davis -Adams, Benitez, Chen, and Davis

Adams, Benitez, Chen, and Davis $340/4 = $85

Solutions to the common pool problem

Assign private property rights Examples: Fishing in the ocean -Fishing ban -Fishing season -Fishing quota -Tradable fishing permit (like the pollution permit)

Which of the following is an example of the free-rider problem? -Both Zoe and Zach receive low-cost dental care at the local dental school, so neither of them pays the full cost of the care. -Alfred receives a free lunch from the local "Meals on Wheels" program because of his low monthly income. Yet his next door neighbor, Alice, is not eligible for the free lunch. -Bruce owns Buster, a large dog who barks whenever anyone walks near his house. Betty lives next to Bruce, and Buster's barking can be heard whenever anyone walks near her house, too. Thus, Betty receives free protection from burglars because of Buster's barking. -Sam purchases a burger at a fast food restaurant and gets a second burger free because the restaurant is having a buy one, get one free sale.

Bruce owns Buster, a large dog who barks whenever anyone walks near his house. Betty lives next to Bruce, and Buster's barking can be heard whenever anyone walks near her house, too. Thus, Betty receives free protection from burglars because of Buster's barking. Betty does not have to pay for the benefits she receives.

Import common resources

Clean Air and water Congested roads Fish, whales, and other wildlife

Suppose that Fayette County is considering adding a guard rail to a dangerous curve by the Kentucky river. The guard rail will cost $70,000. The average damage done to vehicles that slide off the road at the curve is $10,000. It is expected that the guard rail will prevent 5 vehicles from sliding off the road during its usable life. What should the county do? -Install the guard rail because safety is priceless. -Install the guard rail because the benefits exceed the costs. -Do not install the guard rail because the costs exceed the benefits. -Do not install the guard rail at any cost because drivers can purchase private insurance for their vehicles.

Do not install the guard rail because the costs exceed the benefits. 5 X $10,000 = $50,000

free rider problem

For a group, the problem of people not joining because they can benefit from the group's activities without joining. Example: National defense, Public radio

Public goods

Goods that are neither excludable nor rival in consumption When the sirens go off everyone will hear the noise in the surrounding area. You can't make the noise exclusive for a certain group of people. Typically see a market failure with this... Examples: Tornado sirens, national defense, uncongested non- toll road, Broadcast radio wave.

Important public goods

National Defense Basic Research Fighting poverty

Refer to Table 11-4. Suppose the cost to plant each tree is $380 and the 4 homeowners have agreed to split all tree-planting costs equally. Which homeowner(s) would be opposed to planting any trees? -only Davis -only Adams and Davis -only Adams, Benitez, and Davis -Adams, Benitez, Chen, and Davis

Only Davis Reason: The total cost of $380 is divided by 4 people so $380/4 = $95. This is higher than Davis's willingness to pay to plant the first tree.

Tragedy of the Commons (open access resource problem and common pool problem)

Problem of overuse or poor maintence of resources when property rights are not clearly established & the resource is non-excusable

A vacation home near Red River Gorge is -Not rival in consumption and excludable -Rival in consumption and excludable -Not rival in consumption and not excludable -Rival in consumption and not exludable

Rival in consumption and exludable Reason: You owning the vacation home and being able to keep it for yourself means it is excludable, and the fact that no one else can own it if you own it means that it is rival.

Governments role as a producer

So to get efficient scale of provision, the government must provide due to private sector incentive problems.

Which of the following is a disadvantage of government provision of a public good? -The government lacks information about what people are willing to pay for the good. -The government does not provide enough of any public good. -The private sector can provide all public goods at a lower cost. -None of the above is a disadvantage.

The government lacks information about what people are willing to pay for the good. Prices are information, and without prices, there is no information about consumer willingness to pay.

Rivalry in Consumption

The property of a good whereby on person consumes only at the expense of someone else being able to consume the good or one persons use diminishes use by someone else. When a person buys a TV, that specific TV isn't there for someone else to buy Example: Buying a TV on Black Friday

Nonrivalry in consumption

The property of a good whereby ones person's consumption does not limit someone else's from consuming or diminishing someone else's use. Just because someone is listening to the radio doesn't mean another person can't Ex: Listen to the radio in the car

Free-rider

a person who receives the benefit of a good but avoids paying for it

cost-benefit analysis

a study that compares the costs and benefits to society of providing a public good MB>MC

The Tragedy of the Commons will be evident when a growing number of sheep grazing on the town commons leads to a destruction of the grazing resource. To correct for this problem, the town could -allow individual shepherds to choose their own flock sizes. -internalize the externality by subsidizing the production of sheep's wool. -auction off a limited number of sheep-grazing permits. -wait until the market corrects the problem.

auction off a limited number of sheep-grazing permits. If someone owns something, they are much more likely to take care of it than if they do not own it.

Private goods

goods that are both excludable and rival in consumption Easily bought & sold Market process work really well The nature of this market won't cause market failure When one persons use effects another person use it considered a rivalry. Example: House, Car , Sweater , congested toll road

Club Goods

goods that are excludable but not rival in consumption No one person doesn't effect another person using the toll road Example: Cable TV, Satellite, Uncongested toll road

Consider a good for which the number of people who benefit from the good is large and the exclusion of any one of those people is impossible. In this case, the market for this good will likely -be provided by a private firm rather than the government. -have a free-rider problem. -not exist -be limited to a small number of units of production.

have a free-rider problem. Reason: Think of fire protection in Lexington. If you get protection, your neighbor is able to at least in part free-ride off of you.

Common Resources

rival in consumption but not excludable If someone catches a fish and eats it, that specific fish will not be later for another person. Typically see a market failure with this Example: Fish in the ocean , Congested non-toll roads

Excludability

the property of a good whereby a person can be prevented from using it When you keep someone from using the product Ex: Bike, Admission to a theme park

Non excludability

the property of a good whereby a person cannot be prevented from using it When there isn't a link between paying for a product & using the product Ex: Fireworks display