© 2012 Pearson Education. 16 PUBLIC CHOICES AND PUBLIC GOODS.

© 2012 Pearson Education


16PUBLIC CHOICES AND PUBLIC GOODS



Why does government provide some goods and services such as the enforcement of law and order, national defense, and providing good schools and colleges?

Why don’t we let private firms produce all these items and leave people to buy the quantities they demand?

Do governments provide too much or do they provide too little?


Public Choices

A public choice is a decision that has consequences for many people and perhaps for an entire society.

Examples of public choices include:

Decisions by political leaders and senior public servants about price and quantity regulation, taxes, international trade, and government spending.


Public Choices

Why Governments Exist

Governments exist for three reasons. They

1.Establish and maintain property rights.

2.Provide nonmarket mechanisms for allocating scare resources.

3.Implement arrangements that redistribute income and wealth.


Public Choices

Replacing markets with government resource allocation decisions is no simple matter.

Government failure is a situation in which government actions lead to inefficiency

Government failure can lead to overprovision or under provision.


Public Choices

Public Choice and Political Marketplace

Four groups of decision makers are:

Voters

Firms

Politicians

Bureaucrats


Public Choices

Political Marketplace

Voters express their demand via votes.

Voters and firms express their demand for policies via campaign contributions.

Politicians express their supply of policies with proposals which they hope will attract votes.


Public Choices

Bureaucrats try to get the biggest possible budget for their departments and

provide public goods and services.


Public Choices

Political Equilibrium

In a political equilibrium the choices of voters, firms, politicians, and bureaucrats are compatible

and no group can see a way of improving its position by making a different choice.


What Is a Public Good?

What is the essential difference between:

A city police department and Brink’s security?

Fish in the Atlantic Ocean and fish in a fish farm?

A live concert and a concert on television?

These and all goods and services can be classified according to whether they are excludable or nonexcludable and rival or nonrival.

Public Choices


Excludable

A good is excludable if only the people who pay for it are able to enjoy its benefits.

Brink’s security services, East Point Seafood’s fish, and a Coldplay concert are examples.

Nonexcludable

A good is nonexcludable if it is impossible (or extremely costly) to prevent anyone from benefiting from it.

The services of the LAPD, fish in the Pacific Ocean, and a concert on network television are examples.

Public Choices


Rival

A good is rival if one person’s use of it decreases the quantity available for someone else.

A Brink’s truck can’t deliver cash to two banks at the same time. A fish can be consumed only once.

Nonrival

A good is nonrival if one person’s use of it does not decrease the quantity available for someone else.

The services of the LAPD and a concert on network television are nonrival.

Public Choices


A Four-Fold Classification

Private Goods

A private good is both rival and excludable.

A can of Coke and a fish on East Point Seafood’s farm are examples of private goods.

Public goods

A public good is both nonrival and nonexcludable. A public good can be consumed simultaneously by everyone, and no one can be excluded from its benefits.

National defense is the best example of a public good.

Public Choices


Common Resources

A common resource is rival and nonexcludable.

A unit of a common resource can be used only once, but no one can be prevented from using what is available. Ocean fish are a common resource.

They are rival because a fish taken by one person isn’t available for anyone else.

They are nonexcludable because it is difficult to prevent people from catching them.

Public Choices


Natural Monopoly Goods

A natural monopoly good is nonrival and excludable.

A special case of natural monopoly arises when the good or service can be produced at zero marginal cost. Such a good is nonrival. If it is also excludable, it is produced by a natural monopoly.

The Internet and cable television are examples.

Public Choices


Figure 16.2 shows this four-fold classification of goods and services.

Public Choices


Public Choices

Mixed Goods and Externalities

Mixed goods don’t fit neatly into the four-fold classification.

A mixed good is a private good the production or consumption of which creates an externality.

An externality is a cost (external cost) or a benefit (external benefit) that arises from the production or consumption of a private good and that falls on someone other than its producer or consumer.


Public Choices

Mixed Goods with External Benefits

These goods include health care and education.

Mixed Goods with External Costs

These goods include electricity and road, rail, and air transportation produced by burning hydrocarbon fuels (coal, oil, and natural gas).


Public Choices

Inefficiencies that Require Public Choices

Public choices must be made to

Provide public good and mixed goods

Conserve common resources

Regulate natural monopoly


The Free-Rider Problem

A free rider enjoys the benefits of a good or service without paying for it.

Because no one can be excluded from the benefits of a public good, everyone has an incentive to free ride.

Public goods create a free-rider problem—the absence of an incentive for people to pay for what they consume.

Providing Public Goods


The value of a private good is the maximum amount that a person is willing to pay for one more unit of it.

The value of a public good is the maximum amount that all the people are willing to pay for one more unit of it.

To calculate the value placed on a public good, we use the concepts of total benefit and marginal benefit.



Marginal Social Benefit from a Public Good

Total benefit is the dollar value that a person places on a given quantity of a good.

The greater the quantity of a good, the larger is a person’s total benefit.

Marginal benefit is the increase in total benefit that results from a one-unit increase in the quantity of a good.

The marginal benefit of a public good diminishes with the quantity of the good provided.



Figure 16.3 shows that the marginal social benefit of a public good is the sum of marginal benefits of everyone at each quantity of the good provided.

Part (a) shows Lisa’s marginal benefit.

Part (b) shows Max’s marginal benefit.



The economy’s marginal social benefit of a public good is the sum of the marginal benefits of all individuals at each quantity of the good provided.

The economy’s marginal social benefit curve for a public good is the vertical sum of all individual marginal benefit curves.



The marginal social benefit curve for a public good contrasts with the demand curve for a private good, which is the horizontal sum of the individual demand curves at each price.



The Marginal Social Cost of a Public Good

The marginal social cost of a public good is determined in the same way as that of a private good.

The Efficient Quantity of a Public Good

The efficient quantity of a public good is the quantity at which marginal social benefit equals marginal social cost.



Figure 16.4 illustrates the efficient quantity of a public good.

With fewer than 3 airplanes, MSB exceeds MSC.

Resources can be used more efficiently by increasing the quantity.



With more than 3 airplanes, MSC exceeds MSB.

Resources can be used more efficiently if fewer airplanes are provided.

So only at the quantity at which MSB = MSC are resources used efficiently.

Private production would produce 0 airplanes.



Inefficient Private Provision

If a private firm tried to produce and sell a public good, almost no one would buy it.

The free-rider problem results in too little of the good being produced by a private firm.



Efficient Public Provision

Because the government can tax all the consumers of the public good and force everyone to pay for its provision, public provision overcomes the free-rider problem.

If two political parties compete, each is driven to propose the efficient quantity of a public good.

A party that proposes either too much or too little can be beaten by one that proposes the efficient amount because more people vote for an increase in net benefit.



Figure 16.5 illustrates the efficient political outcome.

Two parties, Hopes and Fears, agree on everything except the number of airplanes.

If Hopes propose 2 airplanes and Fears propose 4, voters are equally unhappy and the election is too close to call.



If Hopes increase the number of airplanes to 3, it will win the election if Fears propose 4.

If Fears decrease the number of airplanes to 3, it will win the election if Hopes propose 2.

Both parties propose 3 airplanes and each party gets 50 percent of the votes.



Principle of Minimum Differentiation

The attempt by politicians to appeal to a majority of voters leads them to the same policies—an example of the principle of minimum differentiation.

The principle of minimum differentiation is the tendency for competitors (including political parties) to make themselves similar so as to appeal to the maximum number of clients (voters).

(The same principle applies to competing firms such as McDonald’s and Burger King).



Inefficient Public Overprovision

If competition between two political parties is to deliver the efficient quantity of a public good, bureaucrats must cooperate and help achieve this outcome.

Objective of Bureaucrats

Bureaucrats want to maximize their department’s budget.

A bigger budget increases their status and power.

Bureaucrats might try to persuade politicians to provide more than the efficient quantity.



Rational Ignorance

Rational ignorance is the decision by a voter not to acquire information about a policy or provision of a public good because the cost of doing so exceeds the expected benefit.

For voters who consume but don’t produce a public good, it is rational to be ignorant about the costs and benefit.

For voters who produce a public good, it is rational to be well informed.

When the rationality of uninformed voters and special interest groups is taken into account, the political equilibrium results in overprovision of a public good.



Figure 16.6 shows bureaucratic overprovision.

If rationally ignorant voters enable the bureaucrats to achieve their goal of maximizing their budget,

the public good might be overprovided and

a deadweight loss created.



Providing Mixed Goods with External Benefits

The two largest mixed goods with external benefits are education and health care.

Private Benefits and Social Benefits

A private benefit is a benefit that the consumer of a good or service receives.

Marginal private benefit (MB) is the private benefit from consuming one more unit of a good or service.

An external benefit is a benefit that someone other than the consumer receives.


Marginal external benefit is the benefit from consuming one more unit of a good or service that people other than the consumer enjoy.

Marginal social benefit is the marginal benefit enjoyed by the entire society—by the consumer and by everyone else on whom the benefit falls.

Marginal social benefit is the sum of marginal private benefit and marginal external benefit. That is:

MSB = MB + Marginal external benefit.




Figure 16.7 illustrates the marginal private benefit,

marginal external benefit,

and marginal social benefit.

Marginal external benefit is shown by the vertical distance between the MB and MSB curves.



Figure 16.8 shows how a private market underproduces an item that generates an external benefit

and creates a deadweight loss.



Government Actions in the Market for a Mixed Good with External Benefits

Figure 16.9 illustrates an efficient outcome.

Buyers pay the market price.

Taxpayers must pay the rest of the MSC.



Three devices that the government can use to achieve a more efficient allocation of resources in the presence of external benefits are

Public production

Private subsidies

Vouchers



Public Production

Under public production, a public authority that receives payment from the government produces the good or service.


Private Subsidies

A subsidy is a payment by the government to private producers.

If the government pays the producer an amount equal to the marginal external benefit, the quantity produced is efficient.




Vouchers

A voucher is a token that the government provides to households, which they can use to buy specified goods or services.

The figure shows how vouchers worth $15,000 can achieve an efficient outcome.



Bureaucratic Inefficiency and Government Failure

Public production might lead to underprovision as bureaucrats seek to maximize their budget by budget padding and waste.

The subsidy budget has to be administered by bureaucrats and they might blow out the costs of administration and cut the size of the subsidy.

Producers receiving the subsidy might allocate some of it to lobbying for a larger subsidy and less to production.

These actions will leads to an inefficient outcome.

© 2012 Pearson Education. 16 PUBLIC CHOICES AND PUBLIC GOODS.

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