Eco2023 Public Goods and Common Resources

Free ridder problem

A free rider is someone who enjoys the benefits of a good or service without paying a share of the costs that reflects their true marginal benefit. If all individuals free ride, they will not contribute enough to cover the cost of providing the efficient quantity. Too little of the public good will be produced. In the extreme, if everyone is a complete free rider, none of the public good will be provided.

Marginal Cost of increasing quantity vs. Marginal Cost of increasing number of users

Although the cost of allowing additional individuals to share in a public good once it is provided is zero, the cost of providing more of the good is not. The marginal cost of increasing the quantity of a public good is positive even though the marginal cost of increasing the number of people sharing in it is zero. As with rival goods, the marginal cost to increase the quantity of public good is likely to be increasing as the quantity increases.

Individual transferable quotas

An individual transferable quota is a production limit that is assigned to an individual who is free to transfer the quota to someone else ITQs are similar to marketable permits for internalizing a pollution externality. A market in ITQs emerges, and the market price of an ITQ is the highest price that someone is willing to pay for one. If the efficient quantity of ITQs is assigned, the market price equals that marginal external cost at the efficient quantity.

Public provision of a public good results in overproduction

Because private provision likely results in underproduction of a public good, it has been argued that public goods must be produced by government with decisions about the quantity of each public good made through the political process. But public provision by government through political process is likely to produce a public good because of the incentives of bureaucrats and rational ignorance effect.

Inefficiency in public goods and provision and the rational ignorance effect

Because voters are not well-informed about political issues, politicians and bureaucrats are able to produce more than the efficient quantity of a public good

Why government is large and growing 2

Bureaucratic incentives and rational ignorance rational ignorance on the part of voters allows politicians and bureaucrats to increase the size of government by more than voters would really desire if the voters were fully informed

Inefficiency with Common Resources

Common resources tend to be overused, poorly maintained, and depleted too rapidly.

Private provision of a public good results in underproduction

Private provision in the market it likely to underproduce a public good either because of the free rider problem or because of exclusion

Exclusion problem

Suppose the market attempts to overcome the free rider by charging a price for the public good and excluding non-payers from sharing in it. Individuals whose marginal benefit is positive but less than the price will chose not to share in the public good. But once the good is provided, the marginal cost of allowing them to do so is zero. They will be excluded by the market from sharing in the public good even though there is no cost to allowing them to do so. The result is inefficiency and underproduction of the public good.

Public Goods

a good or service which is non-rival and non-excludable

Production quotas

a production quota is an upper limit to the quantity of a good that may legally be produced a production quota set equal to the efficient quantity can achieve efficient use of a common resource but the large profit on the marginal catch is an incentive to avoid or avid the quota and overfish

Common Resources

a resource for which rights are held in common by a group of individuals none of whom has exclusive ownership. With common resources, property rights are not well-defined and are non-exclusive. An individual has the right to use the resource, but not to change its form or transfer it to other individuals even if transformation or transfer would increase the value of the resource in particular, an individual has no guarantee of future use of the resource, no future interest in the resource

Property rights encourage efficient conservation

a well-specified, complete, and enforced set of private property rights - prevents inefficient overuse of a resource today - provide incentives for efficient maintenance, preservation, conservation for the future, and - ensures against too rapid depletion of a resource

Markets, prices, and resource depletion

as a resource is used up, the supply of the resource decreases, shown by the shift in the supply curve to the left. The higher price also makes it profitable to produce more of the resource from known but perviously uneconomical sources in the long run, higher prices also create incentives...for consumers to substitute other activities that use less of the resource, for producers to develop alternative production methods that use less of the resource and for a search for new sources of supply of the resource and alternatives to it

Property rights

because the overuse of a common resource creates a negative externality, the Coase Theorem suggests that the establishment and enforcement of private property rights might internalize the overuse externality by assigning property rights, common property becomes private property. when someone owns a resource, the owner is confronted with the full consequences of her/his actions when using that resource complete, well-specified, enforced property rights fully internalize both external benefits and external costs

Property rights also prevent too rapid depletion of a resource

contrary to popular belief, resource depletion is less likely to occur with private property rights in resources, competitive markets, and unregulated prices than with common ownership and regulation. Markets and prices provide a self-limiting mechanism that prevents rapid depletion of a valuable resource. As a resource becomes scarcer, its price increases and consumption decreases so that depletion is avoided

Non-rival public good

each unit of the good can be consumed or used simultaneously by multiple individuals Ex: My consumption of a good/service does not reduce the amount available for my friends. My consumption imposes no cost on my friends.

Efficient conservation

greater conservation is not always efficient. as with all other activities, efficient conservation requires balancing the marginal benefit of greater conservation against its marginal cost The MB of conservation is the value of having one more unit of it in the future The MC of conservation is the loss from not using it today Efficient conservation occurs when the MB of conservation equals the MC of conservation

The problem with non-excludability

it is not a characteristic of a good, but rather a choice made about how to supply it and how to pay for it Ex: individuals could be excluded from the benefits of national defense by deporting them Individuals could also be excluded from the benefits of broadcast signals by scrambling the signals. It is the non-rivalry characteristic, NOT non-excludability, that gives rise to problems with private provision of a public good.

Property rights and resource conservation

lack of incentives for conservation with common ownership many people mistakenly believe that resources are more likely to be conserved for the future and less likely to be depleted if they are owned in common than if they are private property. In fact, quite the opposite is true. With common ownership, if one person conserves on current use of a resource to save it for the future, that person bears the full cost of the reduced current use. But that person cannot prevent other users from increasing their current use or from appropriating some of the increased future value of the conserved resource

Non-rival public good examples

national defense, television and radio over-the-air broadcast signals, a lighthouse as far as its signal can be seen, a movie theater up to its seating capacity

Non-excludable public good

once the good is supplied, individuals cant be prevented from sharing in it whether they pay for it or not.

Achieving efficient use of common resources

policies to improve efficiency include: - production quotas - individual transferable quotas - property rights

production quotas as regulation

production quotas are an example of regulatory approach to achieving efficiency they give individuals incentives to find ways to avoid the regulation. They fail to align the incentives of individuals with the social objective they do not achieve the desired reduction in use of the common resource at the lowest possible cost

Rational ignorance effect

refers to the decision by individuals not to acquire relevant information based on the marginal benefits and the marginal costs of acquiring the information. Each voter has little or no effect on the outcome of the political process, so the marginal benefit of becoming informed about political issues is very low or zero while the marginal cost is higher. With the marginal cost of acquiring information greater than its marginal benefit, individual voters make a rational choice not to become informed. They are rationally ignorant.

Property rights and resource conservation 2

resource conservation with common ownership generates positive externalities conservation of a commonly-owned resource generates external benefits so there is too little conservation and too much current consumption of the resource because the only property right a person has in a commonly-owned resource is a non-exclusive right to current use, the incentive is to maximize current use of the resource rather than conserving it

Sources of market inefficiency

taxes and subsidies, regulated prices and quantities (price ceilings, price floors, quotas), positive and negative externalities, public goods, monopoly and other limits to competition

Tragedy of the commons

the absence of incentives to prevent the overuse and depletion of a commonly owned resource.

Efficient quantity of a public good

the efficient quantity of a public good is the quantity at which MSB=MC

Marginal social benefit of a public good

the marginal social benefit of a unit of the public good equals the sum of the marginal private benefits of each of the individuals who share in it. this is because each unit of a public good can be simultaneously consumed by multiple individuals

Inefficiency with common resources 2

the tragedy of the common is a negative externality problem. each individual uses the commons as long as their marginal benefit is greater than the marginal cost. but each individual's use of the commons imposes a cost on other users which is not taken into account. The marginal social cost of using a common resource is greater than the marginal private cost. But individuals base their usage only on their individual marginal private cost, not on the social cost

Objectives of bureaucrats

to maximize profits. when public goods are produced by government, the producer is a government bureau. The objective of a government bureaucrat is to maximize the bureau's budget. Maximizing the bureau's budget is often accomplished by increasing the quantity of the public good or service provided by the bureau.

Why government is large and growing

voter demands drive the growth of the government demands for national and personal security and the demands for other public goods are income elastic as income increases, the demands for these goods and services increases proportionately more than the increase in incomes government grows faster than voters incomes and represents a larger and larger share of the total economy

Efficient use with private property rights

with property rights over the fish, the marginal private cost of fishing equals the marginal social cost, S=MC=MSC private property rights result in efficient use of the resource

resource owners allocate resources to maximize value

with property rights, the owner of a resource bears the cost of conservation but also is guaranteed the full future benefits of conservation resource owners compare the current resource price with the expected future resource price and allocate the resource between current use and conservation for the future to maximize its value.

Efficiency with ITQs

with the efficient quantity of ITQs, the market price of the ITQ equals the marginal external cost the marginal cost of fish becomes MC plus the price of the ITQ MC + Price of ITQ = MSC, so the marginal cost with the ITQ equals the marginal social cost and the equilibrium with the ITQ is efficient

Markets and prices provide incentives for efficient conservation

with well-specified, complete, and enforced property rights in a resource, there are no internalized externalities. Market prices reflect marginal social benefits and marginal social costs therefore, allocating the resource between the present and the future so as to maximize its value based on market prices ensures that the efficient amount of the resource will be conserved for the future.